CHAPTER 45

SHAREHOLDERS’ EQUITY
QUESTION 45-1
Generally, what are the elements constituting shareholders’ equity?
ANSWER 45-1
Shareholders’ equity or stockholders’ equity is the residual interest of the owners in the net assets of a
corporation measured by the excess of assets over the liabilities. Generally, the elements constituting
shareholders’ equity with their equivalent IAS terms are:
Philippine term IAS term
Capital stock Share capital
Subscribed capital stock Subscribed share capital
Common stock Ordinary share capital
Preferred stock Preference share capital
Additional paid in capital Share premium
Retained earnings (deficit) Accumulated profits (losses)
Retained earnings appropriated Appropriation reserve
Revaluation surplus Revaluation reserve
Treasury stock Treasury share

QUESTION 45-2

What is meant by “capital stock” or share capital?

ANSWER 45-2

The term “capital stock” or “share capital” is the amount fixed in the articles of incorporation to be
subscribed and paid in or secured to be paid in by the shareholders of the corporation. Actually, the amount
fixed in the articles of incorporation is called the authorized share capital.

QUESTION 45-3

What are the two classes of share capital? Explain.

ANSWER 45-3

1. Ordinary Share - If there is only one class of share capital, it necessarily is ordinary share. Ordinary
share is so called because the ordinary shareholders have the same rights and privileges. They enjoy no
preference over each other.

The ordinary shareholders have no fixed or specific return on investment. Their economic financial
reward is dependent on the operations of the entity.
2. Preference share -Preference share is so called because of the preferences granted to shareholders. The
preferences usually pertain to the preference shareholders’ claims on dividends and net assets in the
event of liquidation.

The preference shareholders have only a limited or fixed return on investment.

For instance, a holder of a P100 par value, 12% preference share is entitled to an annual dividend, if
declared, of 12 (12% x P100).

QUESTION 45-4

Distinguish a share and a share certificate.

ANSWER 45-4

The share capital is divided into shares evidenced by share certificates. A share represents the interest of a
shareholder in the corporation.

A share certificate is the instrument or document that evidences the ownership of a share.

QUESTION 45-5

Explain the meaning of “subscribed share capital”.

ANSWER 45-5

Subscribed share capital is the portion of the authorized share capital that has been subscribed but not yet
fully paid and therefore still unissued.

The subscribed share capital is reported in the shareholders’ equity minus related subscription receivable
not collectible currently.

QUESTION 45-6

What is share premium? What are the sources of share premium?

ANSWER 45-6

Specifically, “share premium” is the portion of the paid in capital representing the excess over the par or
stated value. Broadly, the common sources of share premium are:

1. Excess over par value or stated value

2. Resale of treasury shares at more than acquisition cost
3. Distribution of stock dividend – market value of share is more than par or stated value.
4. Issuance of share warrants
5. Donated capital
6. Quasi-reorganization and recapitalization

QUESTION 45-7
What are the four basic rights of a shareholder?

ANSWER 45-7

1. To share in the earnings of the corporation

2. To vote in the election of directors and in the determination of certain corporate policies.
3. To subscribe for additional share issues – This is the right of preemption or stock right.
4. To share in the net assets of the corporation upon liquidation

QUESTION 45-8

Distinguish par value share from no par value share.

ANSWER 45-8

1. A par value share is one with specific value fixed in the articles of incorporation and appearing on the
share certificate. The purpose of the par value is to fix the minimum issue price per share.

A no par value share is one without any value appearing on the face of the share certificate. But a no-
par share has always an “issued value” or “stated value” which may be fixed by the articles of
incorporation or board of directors.

2. The minimum stated value of no-par share is P5. The par value of a share can be as low as one centavo.

QUESTION 45-9

What is legal capital? How much is legal capital?

ANSWER 45-9

Legal capital is that portion of the paid in capital arising from the issuance of share capital which cannot be
returned to the shareholders in any form during the lifetime of the corporation.

The amount of legal capital is determined as follows:

1. In case of par value share, legal capital is the aggregate par value of all shares issued and subscribed.
2. In case of no-par value share, legal capital is the aggregate stated value of shares issued and subscribed
plus any excess over stated value.

QUESTION 45-10

Explain the accounting for the issuance of the share capital:

1. With par value

2. Without par value

ANSWER 45-10
1. When shares with par value are sold, the proceeds shall be credited to the share capital account to the
extent of the par value, with any excess being reflected asshare premium.

2. When shares without par value are sold, the proceeds should be credited to the share capital account.

If the no par share has a stated value, the excess of the proceeds over the stated value shall be credited
to share premium.

QUESTION 45-11

Can a share capital be issued at a discount? Explain.

ANSWER 45-11

The Corporation Code provides that “share capital shall not be issued for consideration less than par or
stated value”.

Thiscodal provision is interpreted to mean that when share capital is issued at less than par or stated value,
the issue itself is not void but the agreement that the share shall be paid to the shareholder at a discount is
illegal and cannot be enforced by the shareholder.

Consequently, the issue of the share capital is not canceled but the shareholder must pay for the discount.
This is called the discount liability of the shareholder.

Should the corporation become bankrupt, creditors have a legal right to run after the “discounting”
shareholder.

The account “discount on share capita”l is reported as a deduction from the total shareholders’ equity.

It should be pointed out that the prohibition to issue share at a discount refers to original issue of share but
not to a subsequent transfer of such share by the corporation. Thus, treasury shares may be reissued at less
than par or stated value without violating the legal provision.

QUESTION 45-12

Explain the accounting procedures if the shares are issued in exchange for a non cash consideration.

ANSWER 45-12

The Corporation Code provides that “where the consideration for the issuance of share capital is other than
actual cash or consists of property such as patent or copyright, the valuation thereof shall be initially
determined by the incorporators or the board of directors subject to the approval of the Securities and
Exchange Commission”.
In other words, reference is made to the fair value of the property received, which must be determined by
the incorporators or board of directors, subject to the approval of the Securities and Exchange Commission.

PFRS 2, paragraph 10, provides that for equity-settled share-based payment transactions, the entity shall
measure the goods and services received and the corresponding increase in equity directly at the fair value
of the goods and services received.

However, if the entity cannot estimate reliably the fair value of the goods and services received, the entity
shall measure their value and the corresponding increase in equity indirectly by reference to the fair value of
the equity instruments issued.

Accordingly, if share capital is issued for noncash consideration such as tangible property, intangible asset
and services, the share capital is measured at an amount equal to the following in the order of priority:

a. Fair value of the noncash consideration received

b. Fair value of share capital issued
c. Par or stated value of the share capital issued

QUESTION 45-13

Explain the initial measurement of equity instruments issued to extinguish a financial liability

ANSWER 45-13

In accordance with IFRIC 19, the equity instruments issued to extinguish a financial liability shall be
measured initially at the following order of priority:

a. Fair value of equity instruments issued

b. Fair value of liability extinguished
c. Carrying amount of liability extinguished

QUESTION 45-14

What is the treatment of “share issuance costs”?

ANSWER 45-14

Share issuance costs are direct costs to sell an entity’s own shares, such as underwriting and commission,
accounting and legal fees, printing costs, documentary stamps, filing fees with SEC and cost of advertising
the issue.

Share issuance costs shall be debited to share premium arising from the share issuance.

If the share premium is insufficient to absorb such costs, theexcess shall be expensed immediately.
QUESTION 45-15

What is meant by watered share?

ANSWER 45-15

Watered share is share capital issued for inadequate or insufficient consideration. The consideration
received is less than par or stated value, but the share capital is issued as fully paid.
If the share capital is watered, assets are overstated and capital is correspondingly overstated.

QUESTION 45-16

What is meant by secret reserve?

ANSWER 45-16

The term “secret reserve” is the reverse of watered share. Secret reserve arises when assets are understated
or liabilities are overstated with a consequent understatement of capital.
Secret reserve usually arises from the following:

1. Excessive provision for depreciation, depletion, amortization and doubtful accounts

2. Excessive writedown of receivables, inventories and securities
3. Capital expenditures are recorded as outright expense
4. Fictitious liabilities are recorded.

QUESTION 45-17

Explain briefly the following in connection with the preference sharecapital.

1. Convertible preference share

2. Callable preference share
3. Redeemable preference share

ANSWER 45-17

1. A convertible preference share is one which gives the holder the right to exchange the holdings for
ordinary shares or other securities of the issuing corporation.

2. A callable preference share is one which can be called in at the option of the corporation issuing it for
redemption at a specified price within a specific period of time.

3. A redeemable preference share is one which is redeemable at the option of the holder at a specified
price within a definite period or upon other conditions not solely within the control of the issuer.
 A redeemable preference share is preference share that has a mandatory redemption.

Ordinarily, redeemable preference shares are classified as part of the shareholders’ equity. However,
under PAS 32, a mandatorily redeemable preference share meets the definition of a financial liability
and is classified as such.

Thus, a redeemable preference share shall be presented as current ornoncurrent liabilitydepending on

the redemption date.
The dividend on redeemable preference share shall accounted for as interest expense as component of
finance cost.

QUESTION 45-18

What are stock rights? Explain the accounting procedure for the stock rights.

ANSWER 45-18

Stock rights are granted to existing shareholders usually without consideration to enable them to acquire
new shares at a specified price during a definite period.

The instruments or certificates evidencing ownership of stock rights are known as share warrants. The IAS
term for stock rights is “right issue”.

No entry is required when stock rights are issued. Only a memorandum is necessary to indicate the number
of shares that can be purchased through exercise of stock rights.

The subsequent issuance of new shares through the exercise of stock rights is recorded normally by debiting
cash and crediting share capital and share premium, if any.

QUESTION 45-19

What is meant by treasury shares?

ANSWER 45-19

Treasury shares are an entity’s own shares that have been issued and then reacquired but not canceled.

Treasury shares are not an asset. It is absurd to imply that a corporation can own apart of itself.

Treasury shares may be sold to obtain funds but that possibility does not make treasury shares an asset.

QUESTION 45-20

How much treasury shares can legally be acquired by a corporation?

ANSWER 45-20

The Corporation Code provides that “no corporation shall redeem, repurchase or reacquire its own shares of
whatever class unless it has adequate amount of unrestricted retained earnings to support the cost of said
shares.”

Thus, the corporation can acquire its own shares only to the extent of the retained earnings balance.

If the corporation were allowed to acquire its own shares when it has no retained earnings balance, that
would be tantamount to indirectly returning the legal capital to the shareholders, which is a violation of the
trust fund doctrine.

What is prohibited to be done directly cannot be done by indirection.

QUESTION 45-21

What are the two methods of accounting for treasury shares?

ANSWER 45-21

1. Cost method – The treasury shares are recorded at cost, regardless of whether the shares are acquired
below or above the par value or stated value.

This method is preferred in view of the legal limitation on treasury shares.

If the treasury shares are acquired for cash, the cost is equal to the cash payment.

If the treasury shares are acquired for noncash consideration, the cost is usuallymeasured by the
carrying amount of the noncash asset surrendered.

2. Par value or stated value method – The treasury shares are recorded at an amount equal to the par value
or stated value.

QUESTION 45-22

Explain the accounting treatment for the difference between the cost and sales priceof treasury shares.

ANSWER 45-22

1. If the treasury shares are reissued at more than cost, the “gain” is credited to “share premium from
treasury shares.”
2. If the treasury shares are reissued at less than cost, the “loss” is debited to the following in the order
given:

a. Share premium from treasury shares of the same class

b. Retained earnings

QUESTION 45-23

What is the treatment of the difference between the cost and par or stated value of the treasury shares are
retired instead of being reissued?

ANSWER 45-23

1. If the cost is less than par or stated value, the “gain” is credited to “share premium from treasury
shares.”

2. If the cost is more than par or stated value, the “loss” is debited to the following in the order given:

a. Share premium to the extent of the credit when the shares were issued originally or share premium
from original issuance
b. Share premium from treasury shares of the same class
c. Retained earnings

QUESTION 45-24

How are the treasury shares reported?

ANSWER 45-24

The total cost of the treasury shares is reported as a deduction from shareholders’ equity.The reduction in
equity for treasury shares shall be disclosed separately either on the face of the statement of financial
position or in the notes.

Retained earnings must be appropriated equal to the cost of treasury shares as a restriction on the
availability of retained earnings for dividends.

QUESTION 45-25

Explain the nature of donated shares.

ANSWER 45-25
Donated shares refer to shares received by the corporation from its shareholders by way of donation.
Donated shares are actually treasury shareswithout cost and may therefore be reissued at any price without
any discount liability.

Donated shares are secured without cost and consequently, do not affect the corporation’s assets, liabilities
and shareholders’ equity, although they reduce outstanding shares.

However, the reissue or resale of donated shares increases assets and shareholders’ equity. Thus, the sale of
donated shares is debited to cash or noncash asset received and credited to donated capital. Donated capital
is part of share premium.

QUESTION 45-26

Explain the treatment of the following:

1. Deposits on subscription to a proposed increase in share capital

2. Share assessments

ANSWER 45-26

1. Deposits on description to a proposed increase in share capital may be reported as part of

shareholders’ equity as a separate item.

2. Share assessments usually represent additional contribution from shareholders expressed in a certain
number of pesos per share owned. Share assessments are credited to share premium.

However, if the share assessment is levied on the shareholder because share capital was originally issued at
a discount, the share assessment is recorded by debiting cash and crediting discount on share capital.

QUESTION 45-27

What is recapitalization?

ANSWER 45-27

Recapitalization occurs when there is a change in the capital structure of the entity. The old shares are
canceled and new shares are issued.

The typical recapitalizations are:

1. Change from par to no-par – The old par value share is called in and replaced by new no-par share. If
the original issue price of the old par value share is more than the aggregate stated value of the new no-
par share, the difference is credited to share premium.
 If the original issue price of the old par value share is less than the aggregate state value of the new no-
par share, the difference is charged to retained earnings.

2. Change from no- par to par – The old no-par share is canceled and replaced by new par value share. If
the original issue price of the old no-par share is more than aggregate par value of the new share, the
difference is credited to share premium.

If the original issue price of the old no-par share is less than the aggregate parvalue of the new share,
the difference is charged to retained earnings.

3. Reduction of par value – The old share is cancelled and replaced by a new par value share but with a
reduced par value. The reduction in the par value is credited to share premium.

4. Reduction of stated value – The old share is canceled and replaced by a new no-par share but with a
reduced stated value. The reduction in the stated value is credited to share premium.

5. Split up or share split proper is a transaction whereby the original shares are called in for cancelation
and replaced by a larger number accompanied by a reduction in the par or stated value.

6. Split down or reverse share split is a transaction whereby the original shares are canceled and replaced
by a smaller number accompanied by an increase in the par or stated value.

QUESTION 45-28 Multiple Choice (SFAS 18 Adapted)

1. When shares with par are sold, the proceeds shall be credited to the

a. Share capital account

b. Share premium
c. Retained earnings
d. Share capital account to the extent of the par of the shares issued with any excess being reflected in
share premium

2. When shares without par value are sold, the excess proceeds over the stated value shall be credited to

a. Income
b. Retained earnings
c. Share premium
d. Share capital

3. If shares are issued for a noncash consideration, the shares issued shall be measured by

a. Fair value of the shares issued

b. Par value of the shares issued
c. Fair value of the consideration received
 d. Carrying amount of the consideration received

4. If shares are issued to extinguish a financial liability, what is the initial measurement of the shares
issued?

a. Par value of the shares issued

b. Fair value of the shares issued
c. Fair value of the liability extinguished
d. Book value of the shares issued

5. When shares are issued for services received, the measure is equal to

a. Fair value of such services

b. Par value of the shares issued
c. Book value of the shares issued
d. Fair value of the shares issued

6. Treasury shares shall be recorded at cost irrespective of whether these are acquired below or above par
value. The cost of the treasury shares acquired for noncash consideration is usually measured by

a. Fair value of the noncash consideration given

b. Carrying amount of the noncash asset surrendered
c. Par value of the shares
d. Book value of the shares

7. The total cost of the treasury shares shall be reported as

a. Deduction from shareholders’ equity

b. Asset
c. Deduction from retained earnings
d. Deduction from share premium

8. If treasury shares are reissued for noncash consideration, the proceeds shall be measured by

a. Fair value of the treasury shares

b. Fair value of the noncash consideration received
c. Carrying amount of the noncash consideration received
d. Book value of the treasury shares

9. Which statement is incorrect concerning treasury shares?

a. Treasury shares shall be reported at cost irrespective whether acquired below or above par value
b. The total cost of treasury shares shall be deducted from equity
 c. Treasury shares may be recognized as financial asset
d. Gain or loss on sale of treasury shares shall not be included in profit or loss

10. “Loss” from sale of treasury shares shall be charged to

a. Loss on sale of treasury shares to be shown as other expense

b. Retained earnings and then share premium from treasury shares
c. Share premium from treasury shares then retained earnings
d. Share premium from original issuance, share premium from treasury shares and then retained
earnings

11. Gains and losses on retirement of treasury shares shall not be included in profit or loss. If the
retirement results in a gain, such gain shall be credited to

a. Share premium
b. Retained earnings
c. Share capital
d. Income

12. Loss on retirementof treasury shares shall be debited to

a. Retained earnings
b. Share premium from treasury shares and then to retained earnings
c. Share premium from treasury shares, share premium from original issuance and then to retained
earnings
d. Share premium from original issuance, share premium from treasury shares and then retained
earnings

13. It is issuance by an entity of its own shares to its shareholders without consideration and under
conditions indicating that such action is prompted mainly by a desire to increase the number of shares
outstanding for the purpose of effecting a reduction in unit market price.

a. Share split
b. Reverse share split
c. Stock dividend
d. Recapitalization

14. Subscription receivable and other receivables from sale of shares which are not collectible currently
shall be presented as

a. Deduction from the related subscribed share capital in the shareholders’ equity
b. Current asset
c. Long-term investment
d. Other asset
15. Deposits on subscription to a proposed increase in share capital shall be reported as

a. Part of liabilities
b. Part of shareholders’ equity
c. Memorandum only
d. Part of retained earnings

ANSWER 45-28

1. d 6. b 11. a
2. c 7. a 12. d
3. c 8. b 13. a
4. b 9. c 14. a
5. a 10. c 15. b

QUESTION 45-29

1. In accounting for shareholders’ equity, the accountant is primarily concerned with which of the
following?

a. Determining the total amount of shareholders’ equity

b. Distinguishing between realized and unrealized revenue
c. Recording the source of each or the various elements of the shareholders’ equity
d. Making sure that the directors do not declare dividends in excess of retained earnings

2. Contributed capital does not include

a. Share premium on ordinary and preference shares

b. Preference share capital
c. Capital resulting from reissuance of treasury shares at a price above acquisition price
d. Capital accumulated by retention of earnings

3. Discount on share capital

a. May be recorded as either an asset or an expense

b. Shall be closed to income summary account
c. May be off set against share premium on the same class of share capital
d. None of the above may be done

4. An ordinary shareholder does not possess which of the following?

a. The right to share in the earnings of the corporation when dividends are declared
 b. The right to vote in the election of the board of directors of the corporation
c. The right to direct ownership of the corporate assets
d. The right to share proportionately in corporate assets in case of liquidation if such assets exceed the
claims of the creditors

5. Which of the following is not one of the basic rights of a shareholder?

a. The right to participate in earnings

b. The right to maintain one’s proportional interest in the corporation
c. The right to participate in the proceeds of the sale of corporate assets upon liquidation of the
corporation
d. The right to inspect the accounting records of the corporation

6. An entity issued rights to its existing shareholders to purchase unissued ordinary shares at more than
par value. Share premium would be recorded when the rights

a. Expire
b. Are exercised
c. Become exercisable
d. Are issued

7. Which of the following are issued to shareholders of a corporation to acquire its unissued or treasury
shares within a specified time at a specified price?

a. Share option
b. Share warrant
c. Stock dividend
d. Share subscription

8. Share warrants outstanding shall be reported as

a. Liability
b. Reduction of share premium
c. Share capital
d. Share premium

9. When the total shareholders’ equity is smaller than the amount of contributed capital, this deficiency is
called

a. A net loss
b. A dividend
c. A liability
d. A deficit
10. The par value of an ordinary share represents

a. The liquidation value of the shares

b. The book value of the share
c. The legal nominal value assigned to the share
d. The amount received by the corporation when the share was originally issued

ANSWER 45-29

1. c 6. b
2. d 7. b
3. d 8. d
4. c 9. d
5. d 10. c

QUESTION 45-30 Multiple Choice (AICPA Adapted)

1. When collectability is reasonably assured, the excess of the subscription price over the stated value of
the no-par subscribed share capital shall be recorded as

a. No par share
b. Share premium when the subscription is recorded
c. Share premium when the subscription is collected
d. Share premium when the share capital is issued

2. The issuance of preference shares

a. Increases preference shares outstanding

b. Has no effect on preference shares outstanding
c. Increases preference shares authorized
d. Decreases preference shares authorized

3. When an entity redeems all of its preference shares for more than the original issue price, the excess
paid above the original price shall be

a. Accounted for as loss on exchange in the income statement

b. Charged against share premium of ordinary shares
c. Charged to a discount on preference shares
d. Charged against retained earnings

4. When preference shares are purchased and retired by the issuing entity for less than original issue price,
proper accounting for the retirement
a. Increases the amount of dividends available to ordinary shareholders
b. Increase the contributed capital of the ordinary shareholders
 c. Increases reported income for the period
d. Increases treasury shares held by the corporation

5. The purchase of treasury shares

a. Decreases shares authorized

b. Decreases shares issued
c. Decreases shares outstanding
d. Has no effect on shares outstanding

6. Treasury shares were acquired for cash at more than par value, and then subsequently sold for cash at
more than acquisition price. What is the effect on share premium from treasury shares?

Purchase of Sale of
treasury shares treasury shares

a. Increase Increase
b. Decrease No effect
c. No effect Increase
d. No effect No effect

7. Which of the following statements best describe the net effect on retained earnings of the purchase and
the subsequent sale of treasury shares?

a. Retained earnings may never be increased but sometimes decreased

b. Retained earnings may never be increased or decreased
c. Retained earnings sometimes may be increased but never decreased
d. Retained earnings account is always affected unless the selling price is exactly equal to cost

8. At the date of the financial statements, shares issued would exceed shares outstanding as a result of

a. Declaration of share split

b. Declaration of a stock dividend
c. Purchase of treasury shares
d. Payment in full subscribed shares

9. What is the accounting for treasury shares?

a. On repurchase of treasury shares, a gain or loss is recognized equal to the difference between the
amount at which the shares were issued and the repurchase price for the shares
b. On reissuance of treasury shares, a gain or loss is recognized equal to the difference between the
previous repurchase price and the reissuance price
c. On repurchase or reissuance of previously repurchased own shares, no gain or loss is recognized
 d. Treasury shares are accounted for as financial assets

10. How would the share split in which par value per share decreases in proportion to the number of
additional shares issued affect each of the following?

Share premium Retained earnings

a. Increase No effect
b. No effect No effect
c. No effect Decrease
d. Increase Decrease

ANSWER 45-30

1. b 6. c
2. a 7. a
3. d 8. c
4. b 9. c
5. c 10. b