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BM1705

Corporation
Nature of a Corporation
To form a corporation, most states require individuals, called incorporators, to sign an application and file it with
the proper state official. This application contains the articles of incorporation. If approved by the state, these
articles, which form the company charter, become a contract between the state and the incorporators. The
company is then authorized to do business as a corporation (Needles, Powers, & Crosson, 2014).

The authority to manage a corporation is delegated by its stockholders to a board of directors and by the board
of directors to the corporation’s officers. That is, the stockholders elect a board of directors, which sets corporate
policies and chooses the corporation’s officers, who in turn carry out the corporate policies in their management
of the business (Needles, Powers, & Crosson, 2014).
• Stockholders - A unit of ownership in a corporation is called a share of stock. The articles of incorporation
state the maximum number of shares that a corporation is authorized to issue. The number of shares held
by stockholders is the outstanding stock, which may be less than the number authorized in the articles of
incorporation. To invest in a corporation, a stockholder transfers cash or other resources to the corporation.
In return, the stockholder receives shares of stock representing a proportionate share of ownership
(Needles, Powers, & Crosson, 2014).
• Board of Directors - A corporation’s board of directors decides on major business policies. Among the
board’s specific duties are authorizing contracts, setting executive salaries, and arranging major loans with
banks. The declaration of dividends is another important function of the board of directors. Dividends are
distributions, among the stockholders, of the assets that a corporation’s earnings have generated. Only the
board of directors has the authority to declare dividends (Needles, Powers, & Crosson, 2014).
• Management - Management, appointed by the board of directors to carry out corporate polices and run
day-to-day operations, consists of the operating officers – generally the president, or chief executive officer;
vice presidents; chief financial officer; and chief operating officer. Besides being responsible for running the
business, the management has the duty of reporting the financial results of its administration to the board
of directors and the stockholders. Though management must, at a minimum, make a comprehensive annual
report, it generally reports more often. The annual reports of public corporations are available to the public
(Needles, Powers, & Crosson, 2014).

Characteristics of a Corporation (Abeleda, 2012)


• An artificial being – A corporation is considered as a juridical person and, as such, it is separate and distinct
from the owners. The corporation can acquire properties and incur liabilities in its own name. It can sue and
be sued, except that it cannot be sued criminally.
• Created by operation of law – Before a corporation can be a legal entity, it must comply with all the
requirements provided by the law. The existence and operation must be authorized by the government
through the Securities and Exchange Commission (SEC).
• Right of succession – A corporation’s legal existence is not dissolved by the death or incapacity of a founder
or shareholder/member.
• Powers are expressly authorized by law or are incident to its existence – The powers of a corporation are
derived from the authorization granted by the government, which includes an implied authority to perform
activities and acquire assets necessary to accomplish its objectives or incidental to its existence.
• Additional taxes - Owners of proprietorships and partnerships report their share of earnings on their personal
income tax returns. The individual owner then pays taxes on this amount. On the other hand, corporations
must pay taxes based on the fixed rate mandated by the law. In addition, stockholders must pay taxes on
cash dividends (pro rata distributions of net income). Thus, many argue that the government taxes corporate
income twice (double taxation) – once at the corporate level and again at the individual level (Weygandt,
Kimmel, & Kieso, 2015).

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Kinds of Corporation (Abeleda, 2012)


A. As to Purpose
• Public Corporation – a corporation formed or organized for the governance or administration of a portion
of the state (e.g. provinces, cities, municipalities, and barangays).
• Private Corporation – a corporation created for private purposes by a private sector.
• Quasi-Public Corporation – a private corporation which is held for performing public services as granted
by the state on its contract.

B. As to Membership (Private Corporation)


• Stock Corporation – a corporation whose capitalization is divided into shares of stock (share capital)
and is authorized to distribute to the holders of such shares the corporate earnings in the form of
dividends.
• Non-Stock Corporation – a corporation that has no share capital and whose profits it may generate
incidental to its operations are used for the furtherance of the purpose/s for which the corporation is
organized.

C. As to Nationality or Authority that Grants its Creation


• Domestic Corporation – a corporation organized under Philippine laws.
• Foreign Corporation – a corporation organized under the laws of a foreign country.

D. As to Extent of Membership
• Close Corporation – a corporation whose stock ownership is limited to selected persons or family
members not exceeding 20 persons.
• Open Corporation – a corporation whose share capital is available for subscription or purchase by any
person.

E. As to Relationship to Another Corporation


• Parent or Holding Corporation – a corporation which has the power to either directly or indirectly elect
the majority of the directors of another corporation (called Subsidiary Corporation).
• Subsidiary Corporation – a corporation controlled by another corporation (called Parent Corporation).

F. As to its Legal Right to Corporate Existence


• De Jure Corporation – a corporation existing in fact and in law and has complied with all the
requirements of law pertaining to its formation.
• De Facto Corporation – a corporation existing in fact but not in law, hence, considered as having illegal
corporate business.

Classes of Share Capital (Abeleda, 2012)


A. As to Preference over Dividend/Asset Distribution
• Ordinary Share Capital (formerly called common stock) – an ordinary share capital stock that entitles
the holder thereof (called ordinary shareholder) a pro rata share of dividends declared or a share in the
distribution of the net assets in the event of liquidation without any preference or priority over the other
shareholders.
• Preference Share Capital (formerly called preferred stock) – a special class of share capital that entitles
the holder thereof (called preference shareholder) preference or priority over the ordinary shareholders
with respect to dividend payment or distribution of net assets in the event of liquidation, or both. The
preference share capital (preferred stock) can be further classified as follows:
 Non-Cumulative Preference Share Capital – The holder is entitled to receive only the current year’s
fixed dividend in the event of a dividend declaration. The past years’ undeclared dividends are
forfeited.
 Cumulative Preference Share Capital – The holder has the right to collect dividends in arrears
(dividends not declared for the past years) including the current year’s dividend before the dividend
payments can be made to the ordinary shareholders.
 Non-Participating Preference Share Capital – The holder is not entitled to receive additional
dividend beyond its fixed dividend stipulated in the Articles of Incorporation. Earnings declared in

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excess of the current year’s preference share dividend would all be distributed to the ordinary
shareholders.
 Participating Preference Share Capital – The holder has the right to receive additional dividend in
excess of the fixed dividend but only after both the preference and ordinary shareholders have
received the same percentage of dividend. The excess earnings declared will be distributed in a
pro rata basis.

B. As to Value Assigned to the Share Capital


• Par Value Share Capital – This is a share capital that contains a specific or fixed value (called par value)
per share printed in the stock certificate, a document, which serves as a proof of stock (share capital)
ownership.
Note: A par value share capital cannot be sold and issued originally at a price less than the par value.
• No Par Value Share Capital – This is a share capital without a specific value per share printed in the
stock certificate.
Note: Because this class of share capital has no par value, the minimum price (called stated value) must be
stipulated in the Articles of Incorporation. Additionally, the amount per share must not be less than P5. However, if
it is a pure no par value share capital with no stated value, then it has no minimum value per share.

C. As to Voting Power
• Voting Share Capital – a share capital that has a voting right.
• Non-Voting Share Capital – a share capital that has no voting right.

D. Others
• Treasury Share – a share capital issued and subsequently acquired back by the corporation with the
intention of re-selling or re-issuing it.
• Convertible Share – a convertible preference share capital; this may be converted into another class of
share capital or corporate securities at the option of the holder.
• Delinquent Share – a subscribed share capital (contracted to be purchased) and paid partially but the
subscriber defaulted in paying the balance of the subscription.
• Founder’s Share – a usual privileged stock that is issued to the founders of the corporation.
• Promotion Share – a share capital issued to the promoters responsible for organizing the corporation;
a share capital issued to owners of natural resources or rights connected therewith as compensation
for transferring their ownership or rights to the corporation.
• Redeemable Share – a share capital callable at some future date at the option of the corporation.

Classification of Shares of Stock (Share Capital)


A stock certificate is an evidence of stock ownership indicating the number of shares subscribed and paid.
The shares of stock (share capital) held for recording and/or reporting purposes may be classified as follows:
• Authorized Shares –the maximum number of shares a corporation is allowed to share or issue.
• Subscribed Shares – the number of shares subscribers or buyers contracted to purchase in the shares of
stock or share capital.
• Unissued Shares – the shares not yet subscribed or already subscribed but not yet fully paid.
• Issued Shares – the subscribed and fully paid shares (stock certificates have been issued).
• Treasury Shares – the number of shares previously issued but acquired back by the corporation. These are
shares in the hands of the corporation.
• Outstanding Shares – the number of shares subscribed and issued minus the treasury shares (shares
entitled to dividends).

Accounting for a Corporation

Recall that a corporation’s owners’ equity is called stockholders’ equity. Laws require corporations to report their
sources of capital because some of the capital must be maintained by the company (Horngren, Harrison Jr., &
Oliver, 2012).

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• Paid-in capital (also called contributed capital) represents amounts received from the stockholders.
Common stock is the main source of a paid-in capital. A paid-in capital is externally generated capital and
results from transactions with outsiders.
• Retained earnings are the capital earned by profitable operations. Retained earnings are internally
generated capital because they result from corporate decisions to retain net income to use in future
operations or for expansion.

Share Capital (Capital Stock) Transactions

In recording the share capital transactions of a corporation, there are two (2) methods, depending on the
accounts, to be used. These are the journal entry method and the memorandum entry method.
The following accounts are used under the journal entry method (Abeleda, 2012):
• Authorized Share Capital – This account is the total amount of capital stock that a corporation is authorized
to sell or issue as stated in the Articles of Incorporation.
• Unissued Share Capital – This account is the total amount of capital stock not yet sold or issued by the
corporation.
• Subscribed Share Capital – This account is the portion of the authorized share capital which has been
subscribed by the stockholders. This is recorded at par value or stated value.
• Subscriptions Receivable – This account is the portion of the subscribed share capital which remains
uncollected.
• Share Premium (formerly called Paid-in Capital) – This account is the excess of the subscription price over
the par value of the share capital subscribed or issued.
• Share Capital in Excess of Stated Value – This account is the excess of the subscription price over the
stated value of a no par value share capital subscribed or issued.

Note: If the share capital has no par value or stated value, it is not possible to use the journal entry method.

The same accounts mentioned earlier are used in memorandum methods except the Authorized Share Capital
and Unissued Share Capital. These will be replaced by a single account called Share Capital.
• Share Capital – This account represents the total amount of share capital fully paid and already issued by
the corporation.

The comparative pro-forma journal entries relating to the formation of a corporation and other subsequent
transactions under the two (2) methods are summarized as follows:
1. Approval by the SEC of the Articles of Incorporation

Journal Entry Method Memo Entry Method


Unissued Share Capital xxx Share Capital
Authorized Share Capital xxx Authorized with par 50,000 shares of P10
value per share

Two (2) separate accounts are used to record the approval of the authorized share, under journal entry
method, while a single account is used and a memo entry is made in general ledger, under memo entry
method.

2. Subscription to the share capital by the incorporators

Journal Entry Method Memo Entry Method


Subscription Receivable xxx
Subscribed Share xxx Same Entry

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3. Collection of subscription (partial or full)

Journal Entry Method Memo Entry Method


Cash xxx
Subscription Receivable xxx Same Entry

4. Issuance of stock certificate upon full payment

Journal Entry Method Memo Entry Method


Subscribed Share Capital xxx Subscribed Capital xxx
Unissued Share Capital xxx Share Capital xxx

5. Payment of expenses relating to the information of the corporation

Journal Entry Method Memo Entry Method


Organization Expense xxx
Cash xxx Same Entry

Note that except for the entry to record the share capital authorization and the entry record the issuance of stock
certificate, the entries for all the other share capital transactions are the same under both methods.

Illustration:

Share Capital Authorization


1. ABC Corporation was authorized to issue the following: 5,000 preference share with a par value of P15 per
share and 20,000 ordinary shares with no par value but with stated value of P10 per share.

Journal Entry Method


Unissued Preference Share Capital (5,000 x P15) P 75,000
Unissued Ordinary Share Capital (20,000 x P10) 200,000
Authorized Preference Share Capital P 75,000
Authorized Ordinary Share Capital 200,000

Memo Entry Method


Preference Share Capital Ordinary Share Capital
Authorized 5,000 shares with a par value of Authorized 20,000 shares, no par value, with
P15 per share stated value of P10 per share

Share Capital Subscriptions by the Incorporators


2. The incorporators subscribed a total of 2,000 preference shares and 5,000 ordinary shares.

Preference Subscription Receivable (2,000 x P15) P 30,000


Ordinary Subscription Receivable (5,000 x P10) 50,000
Subscribed Preference Share Capital P 30,000
Subscribed Ordinary Share Capital 50,000

Partial Payment of Subscription


3. The subscribers paid 25% of their subscriptions.

Cash P 20,000
Preference Subscription Receivable (30,000 x 25%) P 7,500
Ordinary Subscription Receivable (50,000 x 25%) 12,500

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Full Payment of Subscription


4. The incorporators paid their subscriptions in full.

Cash (80,000 x 75%) P 60,000


Preference Subscription Receivable (30,000 x 75%) P 22,500
Ordinary Subscription Receivable (50,000 x 75%) 37,500

Issuance of Stock Certificates


5. The corresponding stock certificates were issued.

Journal Entry Method


Subscribed Preference Share Capital P 30,000
Subscribed Ordinary Share Capital 50,000
Unissued Preference Share Capital P 30,000
Unissued Ordinary Share Capital 50,000

Memo Entry Method


Subscribed Preference Share Capital P 30,000
Subscribed Ordinary Share Capital 50,000
Preference Share Capital P 30,000
Ordinary Share Capital 50,000

Share Capital Subscription at Par Value or Stated Value with Down Payment
6. 500 preference shares at par value and 800 ordinary shares at stated value were subscribed with 50%
down payment.

Cash (15,500 x 50%) 7,750


Preference Subscription Receivable (7,500 x 50%) 3,750
Ordinary Subscription Receivable (8,000 x 50%) 4,000
Subscribed Preference Share Capital (500 x 15) 7,500
Subscribed Ordinary Share Capital (800 x 10) 8,000

Share Capital Subscriptions Higher than the Par Value and Stated Value
7. 100 preference shares at P16 per share and 300 ordinary shares at P12 per share were subscribed.

Preference Subscription Receivable (100 x 16) 1,600


Ordinary Subscription Receivable (300 x 12) 3,600
Subscribed Preference Share Capital (100 x 15) 1,500
Subscribed Ordinary Share Capital (300 x 10) 3,000
Preference Share Premium (100 x 1) 100
Ordinary Share Capital in Excess of Stated Value (300 x 2) 600

NOTE: If the amount paid is in excess of the par value or stated value, the Subscribed Share Capital account
must be credited at par or stated value so that a Share Premium account or a Share Capital in Excess of
Stated Value account can be recognized.

Share Capital Issuance for Cash at Par Value or Stated Value


8. Received cash subscriptions of 50 preference shares at par value and 100 ordinary shares at stated value.

Journal Entry Method


Cash 1,750
Unissued Preference Share Capital (50 x 15) 750
Unissued Ordinary Share Capital (100 x 10) 1,000

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Memo Entry Method


Cash 1,750
Preference Share Capital (50 x 15) 750
Ordinary Share Capital (100 x 10) 1,000

Share Capital Issuance for Cash at a Price Higher Than the Par or Stated Value
9. Sold 100 preference shares for cash at P16 per share and 200 ordinary shares at P11 per share.

Journal Entry Method


Cash 3,800
Unissued Preference Share Capital (100 x 15) 1,500
Unissued Ordinary Share Capital (200 x 10) 2,000
Preference Share Premium (100 x 1) 100
Ordinary Share Capital in Excess of Stated Value (200 x 1) 200

Memo Entry Method


Cash 3,800
Preference Share Capital (50 x 15) 1,500
Ordinary Share Capital (100 x 10) 2,000
Preference Share Premium (100 x 1) 100
Ordinary Share Capital in Excess of Stated Value (200 x 1) 200

NOTE: Under the corporation code, the share capital cannot be sold lower than the par value or stated
value.

Journal Entry Method

Unissued Preference Share Capital Unissued Ordinary Share Capital


(1) 75,000 (5) 30,000 (1) 200,000 (5) 50,000
(8) 750 (8) 1,000
(9) 1,500 (9) 2,000

Authorized Preference Share Capital Authorized Ordinary Share Capital


(1) 75,000 (1) 200,000

Memo Entry Method

Preference Share Capital Ordinary Share Capital


(1) Authorized 5,000 shares par (1) Authorized 20,000 shares
value, P15 per share stated value P10 per share
(5) 30,000 (5) 50,000
(8) 750 (8) 1,000
(9) 1,500 (9) 2,000

Preference Subscriptions Receivable Ordinary Subscriptions Receivable


(2) 30,000 (3) 7,500 (2) 50,000 (3) 12,500
(6) 3,750 (4) 22,500 (6) 4,000 (4) 37,500
(7) 1,600 (7) 3,600

Subscribed Preference Share Capital Subscribed Ordinary Share Capital


(5) 30,000 (2) 30,000 (5) 50,000 (2) 50,000
(6) 7,500 (6) 8,000
(7) 1,500 (7) 3,000

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Preference Share Premium Ordinary Share Capital in Excess of SV


(7) 100 (7) 600
(9) 100 (9) 200

The balances of the accounts used will be presented in the Shareholders’ Equity portion of the Balance Sheet.

Shareholders’ Equity

Journal Entry Method


Authorized Preference Share Capital P 75,000
Less: Unissued Preference Share Capital 42,750
Issued Preference Share Capital P 32,250
Subscribed Preference Share Capital P 9,000
Less: Preference Subscriptions Receivable 5,350 3,650
Paid-in Preference Share Capital P 35,900
Authorized Ordinary Share Capital P 200,000
Less: Unissued Ordinary Share Capital 147,000
Issued Ordinary Share Capital P 53,000
Subscribed Ordinary Share Capital P 11,000
Less: Ordinary Subscriptions Receivable 7,600 3,400
Paid-in Ordinary Share Capital 56,400
Total Paid in Share Capital P 92,300
Add: Preference Share Premium P 200
Ordinary Share Capital in Excess of Stated Value 800 1,000
TOTAL SHAREHOLDERS’ EQUITY P 93,300

Memo Entry Method

Preference Share Capital, 5,000 shares Authorized, par


value P15, Issued 750 shares P 32,250
Subscribed Preference Share Capital P 9,000
Less: Preference Subscription Receivable 5,350 3,650
Paid-in Preference Share Capital P 35,900
Ordinary Share Capital, 20,000 shares Authorized, stated
value, P10, Issued 2,300 shares P 53,000
Subscribed Ordinary Share Capital P 11,000
Less: Ordinary Subscriptions Receivable 7,600 3,400
Paid-in Ordinary Share Capital 56,400
Total Paid in Share Capital P 92,300
Add: Preference Share Premium P 200
Ordinary Share Capital in Excess of Stated Value 800 1,000
TOTAL SHAREHOLDERS’ EQUITY P 93,300

NOTE: The total shareholders’ equity will be the same whether the journal entry method or the memo entry
method will be used. The difference mainly lies in the manner of presentation and the accounts used.

Share Capital issuance for Non-Cash Consideration

A share capital can be issued as a non-cash consideration. If so, the asset received in exchange for the share
capital must be valued using the order of priority as follows:
• The value of the asset received must be at fair market value if it is given.
• The value of the asset received will be based on the fair market value of the share capital issued, if the
market value of the asset is not given.
• An independent appraisal will be made if both market value of asset received and market value of share
capital issued are not present. The appraised value of the asset received will be the basis for valuation.

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• If none of the three (3) values are given, the value of asset received will be based at par value or stated
value.

Share Capital Issuance for Payment of Liability

In distinct situation, a capital stock or share capital is issued by a corporation to fulfill their obligations or payment
of loans. Unissued Share Capital or Share Capital will be credited, and a liability account will be debited. If the
liability is greater than the amount of share capital issued, the excess will be credited to Share Premium or
Share Capital in Excess of Stated Value account (Abeleda, 2012).

Share Capital Issuance for Services Rendered Related to the Formation of the Corporation

During the formation of a corporation, capital stock or share capital may be issued as payment for services
rendered (e.g. legal fees). Organization Expense account will be debited and Unissued Share Capital or Share
Capital account will be credited at par value or stated value. A Share Premium or Share Capital in Excess of
Stated Value account will be credited if expense is more than the issued share capital. An adjustment to
organization expense account will be made if the expense is less than the issued share to make it equal (par
value) with the issued share capital (Abeleda, 2012).

Delinquent Share Capital Subscription (Defaulting Subscriber)

Sometimes subscribers are not able to accomplish to pay their subscription’s balance on due date (call date). If
they are still unable to pay after repeated demands and notices for payment, the corporation is allowed by the
law to sell the delinquent shares (shares unpaid) at a public auction. An advertisement by the corporation will
be announced in a local newspaper for the sale of delinquent shares. The notice of bidding will specify the date
of opening of the accepted bid offers. At the opening of the sealed bids, the “highest bidder” will be determined
after which s/he would be required to pay the amount of his/her bid for the delinquent shares. The shares of
stock to be issued to the defaulting subscriber will be the subscribed shares less the shares bid by the highest
bidder.
The one who is willing to pay the uncollected balance of the subscription (plus accrued interest, advertising
cost, and other expenses relating to the sale of the delinquent shares) is considered as the highest bidder for
the least number of shares (Abeleda, 2012).

Accounting for Treasury Shares

Treasury Shares are the corporation’s own share capital issued previously to a shareholder and acquired back
by the same corporation with the intention of re-issuing (reselling) to another prospective investor or
shareholder. Reselling of stock to other prospective shareholders is the purpose of acquiring treasury shares.
The stock certificate will not be cancelled; instead, it will just be transferred from the original shareholder to the
new shareholder after it is re-issued (Abeleda, 2012).

The following are treasury shares’ characteristics and limitations because it belongs to the corporation (Abeleda,
2012):
• They have no voting right.
• They are not entitled to dividends.
• They have no “pre-emptive right” (the right to acquire new shares of stock or share capital that the
corporation will issue).
• They can only be acquired if the corporation has an adequate amount of unrestricted retained earnings
equivalent to the amount of treasury shares to be acquired.
• Retained earnings must be appropriated to the extent of cost of the treasury shares to be acquired prior to
the acquisition (to be reserved after reissuance).
• Treasury shares are not considered as assets. They are shown in the Balance Sheet as deduction from the
“Shareholder’s Equity”.

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The accounting problems that may be encountered relating to treasury shares are the following (Abeleda, 2012):
• Acquisition of Treasury Shares

Treasury shares may be acquired through any of the following means:


• Acquisition of Treasury Shares by Purchase. Under the cost method of accounting for treasury shares,
the amount paid by the corporation to acquire the stock (whether the amount is equal to or more or less
than the par value or state value) will be the cost assigned to the treasury shares (Abeleda, 2012).

Illustration: A Corporation acquired 100 shares of its own stock with a par value of P20 per share.
a. The acquisition price was P18 per share

Treasury Shares (100 x P18) 1,800


Cash 1,800

b. The acquisition price was P23 per share

Treasury Shares (100 x P23) 2,300


Cash 2,300

c. The acquisition price was at par value

Treasury Shares (100 x P20) 2,000


Cash 2,000

NOTE: No gain or loss is recognized if the treasury shares are recorded at cost regardless of acquisition
price.

• Acquisition of Treasury Shares through Donation. No cost will be assigned to the treasury shares if it is
acquired through a donation from an existing shareholder/s, because no monetary consideration is
involved. The only effect of this donation is merely to reduce the number of shares outstanding (shares
in the hands of the shareholders). This kind of treasury share is called Share Capital from Donation
(Abeleda, 2012).

Illustration: The Corporation received 500 shares with a par value of P20 as donation from a
shareholder.

No entry is made in the general journal. Instead, a memo entry is made in the general ledger under the
account title “Treasury Shares” as illustrated.

Treasury Shares Alternatively, the memo entry can be made


under the account title Share Capital from
Received 500 shares As donation from Mr. X
Donation. This is the account used when the
treasury shares are reissued or sold.

• Acquisition through Payment of a Debtor-Shareholder. In some cases, a shareholder can also be a


debtor of the corporation. The debtor may opt to surrender his/her shares of stock (share capital) in
payment of his account with the corporation. With this, the amount of the receivable will be the cost to
be assigned to the treasury shares that is offset to the shares of stock (Abeleda, 2012).

Illustration: Mr. A owed X Corporation P10,000. He surrendered his stock certificate for 100 shares with
a par value of P90 per share in full payment of his account.

Treasury Shares 10,000


Advances or Accounts Receivable 10,000

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• Reissue of the Treasury Shares

The following rules must be observed when recording the transaction of reissued or sold treasury shares
(Abeleda, 2012):
• If the reissue price and the cost of the treasury shares are equal, cash is debited and Treasury Shares
account is credited. (No gain or loss)
• If the reissue price is higher than the cost of the treasury shares, the excess of the reissue price is
credited to the Treasury Shares Premium account. (Gain on reissue)
• If the reissue price is lower than the cost of the treasury shares, the difference is first debited to Treasury
Shares Premium account to the extent of its balance, if any, and the remainder is debited to Retained
Earnings account. (Loss on reissue)

Illustration: Mac Corporation acquired back 2,000 shares of its own P100 par value share capital at P125
per share.

Treasury Shares (2,000 x P125) 250,000


Cash 250,000

Subsequently, the treasury shares were reissued as follows:


a. 1,000 shares were reissued (sold for cash) at P125 per share
Cash (1,000 x P125) 125,000
Treasury Shares 125,000

b. 500 shares were reissued at P130 per share


Cash (500 x P130) 65,000
Treasury Shares (500 x 125) 62,500
Treasury Shares Premium (500 x 5) 2,500

c. The remaining 500 shares were reissued at P98 per share

Cash (500 x P98) 49,000


Treasury Shares Premium 2,500
Retained Earnings 11,000
Treasury Shares 62,500

• Retirement of Treasury Shares

The original intention of acquisition of Treasury Shares is for reissuing or selling it, but if any of the board of
directors doesn’t desire or isn’t interested to buy, the corporation may cancel or retire the treasury shares.
The entries to be recorded for the retirement of treasury shares will depend on the original issuance cost,
acquisition cost, and par value or stated value (Abeleda, 2012).

Illustration: Mac Corporation sold 100 shares with a par value of P50 to ABC Corporation.

Cash 5,000
Share Capital 5,000

Case 1 – The cost of the Treasury Shares is the same as the par value (no gain or loss on retirement)
(Abeleda, 2012).
a. The corporation acquired back the 100 shares sold to ABC Corporation at par value

Treasury Shares (100 x P50) 5,000


Cash 5,000

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b. The treasury shares were retired and cancelled

Share Capital 5,000


Treasury Shares 5,000

Case 2 – The cost of the Treasury Shares is less than the par value (gain on retirement) (Abeleda, 2012).
a. The corporation acquired back the 100 shares sold to ABC Corporation at P45 per share

Treasury Shares (100 x P45) 4,500


Cash 4,500

b. The treasury shares were retired and cancelled

Share Capital (100 x P50) 5,000


Treasury Shares (100 x P45) 4,500
Share Capital from Retirement of Treasury Shares (100 x P5) 500

Case 3 – The cost of the Treasury Shares is more than the par value (loss on retirement) (Abeleda, 2012).
a. The corporation acquired back the 100 shares sold to ABC Corporation at P52 per share

Treasury Shares (100 x P52) 5,200


Cash 5,200

b. The treasury shares were retired and cancelled

Share Capital (100 x P50) 5,000


Retained Earnings (100 x P2) 200
Treasury Shares (100 x P52) 5,200

Accounting for Dividends

Dividends are the corporate earnings distributed to shareholders in proportion to the number of shares held by
them. In the event of liquidation, these can refer to the amount of capital to be returned to the shareholders.

Based form the definition, there are two (2) types of dividends:
• Dividends Out of Earnings. These are corporate earnings distributed to the shareholders generated from
the profitable operations of the corporation.
• Liquidating Dividends. These are net assets of the corporation that are realized in liquidation that are to be
distributed among the shareholders.

Dividends Out of Earnings

The corporation code provides that before the profits of the corporation can be distributed as dividends, there
must be a declaration to this effect by the board of directors. The dividends can only be declared out of the
unrestricted (free) retained earnings. Declaring dividends if there is a deficit (retained earnings with a debit
balance) or the amount of dividends exceeds the unrestricted retained earnings is illegal for a corporation
(Abeleda, 2012).

The following are three (3) significant dates pertaining to dividends:


• Date of Declaration – the date when the board of directors approved the resolution to distribute dividends.
The liability to shareholders is recorded on this date.

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The pro forma entry to record the dividend declaration is:

Retained Earnings xxx


Dividends Payable xxx

NOTE: The Dividends Payable account is shown in the Balance Sheet as current liability.

• Date of Shareholders of Record – the date when the company determines the shareholders who are entitled
to the receipt of declared dividends. The Stock and Transfer Book will be closed for registration on this date.
After this date, any shareholder who registers will not be entitled to receive the declared dividends on the
date of declaration. NOTE: On this date, no entry is required.

• Date of Payment – the date when dividends declared are paid to the shareholders.

The pro forma entry to record the dividend payment is:

Dividends Payable xxx


Cash xxx

Illustration: The board of directors in their meeting on May 15, 200C declared a cash dividend of P10 per share
to all shareholders of record as of June 15, 200C, payable on September 30, 200C.

Date of Declaration May 15


Date of Shareholders of Record June 15
Date of Payment September 30

Dividends to be paid may be in the form of any of the following:


• Cash Dividends are payable in cash and may be expressed as: (a) percentage of the par value or stated
value, and (b) peso amount per share (Abeleda, 2012).

Illustration: The Board of Directors of Mac Corporation declared a cash dividend of P10 per share on
December 15, 200C to all shareholders of record as of December 31, 200C payable on January 31, 200D.
Assuming that 10, 000 shares are outstanding (in the hands of the shareholders registered as of December
31, 200C), then:

December 15 Retained Earnings (10,000 x 10) 100,000


Dividends Payable 100,000

December 31 No Entry

January 31 Dividends Payable 100,000


Cash 100,000

• Property Dividends are dividends payable in the form of non-cash assets (usually in the form of
merchandise). The non-cash assets to be distributed as dividends must be valued at cost or book value
(Abeleda, 2012).

Illustration: Merchandise costing P25,000 with a selling price of P40,000 was declared as dividends and
was later distributed to the shareholders.

Declaration Retained Earnings 25,000


Property Dividends Payable 25,000

Distribution Property Dividends Payable 25,000


Merchandise 25,000

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• Scrip or Liability Dividends are dividends payable in the form of scrip (promissory notes) and will be paid
at future time. They exist to extend the payment period of the dividends. Like promissory notes, scrip
dividends may or may not bear interest (Abeleda, 2012).

Illustration: On June 1, 200F, the Board of Directors declared a 20% cash dividends on its 10,000 shares
outstanding with a par value of P50 per share to all shareholders of record as of July 1, 200F. The scrips
(promissory notes) were issued on July 1, 200F. The scrip dividends were redeemed on December 31,
200F with a per annum interest of 10%.

June 1 Retained Earnings (10,000 x P50 x 20%) 100,000


Scrip Dividends Payable 100,000

July 1 Scrip Dividends Payable 100,000


Notes Payable to Shareholders 100,000

December 31 Notes Payable to Shareholders 100,000


Interest Expense (100,000 x 6/12 x 10%) 5,000
Cash 105,000

• Stock Dividends (Bonus Issues) are dividends payable in the form of the corporation’s own share capital.
These may come from unissued share capital or treasury shares. These are expressed as a percentage of
the outstanding shares (issued shares less treasury shares, if any) (Abeleda, 2012).
o Ordinary stock dividend are dividends distributed to the same type of shareholder (i.e., ordinary
shareholders are distributed ordinary share capital and preference shareholders are issued preference
share capital).
o Special stock dividend is a dividend where a different class of stock is issued to a specific class of
stock (i.e., ordinary shareholders are issued preference share capital or vice versa).

Illustration: The shareholders’ equity accounts of Mac Corporation are presented below:

Share Capital, P100 par, 10,000 shares authorized 6,000 shares issued P600,000
Share Premium 60,000
Retained Earnings 300,000

Assume that a 10% stock dividend is declared and the market price of the share capital is P120 per share.

Declaration Retained Earnings (6,000 x P120 x 10%) 72,000


Stock Dividends Distributable (6,000 x P100 x 10%) 60,000
Share Capital from Stock Dividends 12,000

Issuance Stock Dividends Distributable 60,000


Share Capital 60,000

• Cash Dividends (Two Classes of Share Capital) are instances that a corporation issues two (2) classes
of share capital (preference share and ordinary share). The computation of the dividends per share for each
class of share capital should give recognition to the special privileges, rights, or preferences of the
preference shareholders. Among the rights or privileges of the shareholders of the preference share are the
following (Abeleda, 2012):
o Preference as to Dividends. When a corporation declares cash dividends, those who hold preference
shares must be paid first before any dividend is distributed to the holders of ordinary shares. In the case
of liquidating dividends, this preference does not apply unless it is expressly stipulated in the Articles of
Incorporation.
o Cumulative Right. Dividends in arrears (dividends for the previous year/s not declared) can still be
collected by the holders of preference shares.
o Participating Right. The preference shareholders can receive dividends in excess of the fixed dividend
rate but only after the ordinary shareholders receive the same rate.

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Illustration: The shareholders’ equity accounts of Mac Corporation showed the following balances on
December 31, 200C:

12% Preference Share Capital, par P50, authorized 50,000 shares 40,000 share issued P2,000,000
Ordinary Share Capital, par P30, authorized 250,000 shares 200,000 shares issued 6,000,000
Ordinary Share Premium 600,000
Retained Earnings 3,000,000

The Corporation declared cash dividends of P1,500,000 on December 31, 200C. There was no dividend
declaration for the past two (2) years.

CASE 1. The preference shares are non-cumulative and non-participating


Dividends Preferences Ordinary
Total dividends declared 1,500,000
Current preference dividends (12% x 2,000,000) (240,000) 240,000
Balance to ordinary shares 1,260,000
Ordinary dividends (1,260,000) 1,260,000
Distribution of dividends 0 240,000 1,260,000
Divide by outstanding shares 40,000 200,000
Dividends per share P 6.00 P 6.30

The preference shareholders have priority as to dividends, hence, they should be paid first before the
ordinary shareholders. Because the preference shares are non-cumulative, dividends in arrears are
forfeited. Furthermore, because the preference shares are non-participating, all the dividends will go to the
ordinary shareholders after subtracting the current year’s preference dividends. The preference dividends
per share can be easily computed under this case by multiplying the dividend rate of 12% by the par value
of P50 (P50 x 12%) = P6.00 per share (Abeleda, 2012).

CASE 2. The preference shares are cumulative and non-participating


Dividends Preferences Ordinary
Total dividends declared 1,500,000
Past preference dividends (12% x 2,000,000 x 2) (480,000) 480,000
Current preference dividends (240,000) 240,000
Balance to ordinary shares 780,000
Ordinary dividends (780,000) 780,000
Distribution of dividends 0 720,000 780,000
Divide by outstanding shares 40,000 200,000
Dividends per share P 18.00 P 3.90

Because the preference shares are cumulative, the total dividends should include the past two (2) years’
dividends which were not declared. After satisfying the preference shares, the balance of the dividends
declared will all go to the ordinary shareholders since the preference shares are non-participating (Abeleda,
2012).

CASE 3. The preference shares are non-cumulative but fully participating


Dividends Preferences Ordinary
Total dividends declared 1,500,000
Current preference dividends (12% x 2,000,000) (240,000) 240,000
Ordinary dividends (12% x 6,000,000) (720,000) 720,000
Balance: Pro rata 540,000
Preference (2/8 x 540,000) (135,000) 135,000
Ordinary (6/8 x 540,000) (405,000) 405,000
Distribution of dividends 0 375,000 1,125,000
Divide by outstanding shares 40,000 200,000
Dividends per share P 9.375 P 5.625

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The participating right entitles the preference shareholders to receive dividends more than their fixed
dividend rate of 12% but only after the ordinary shareholders have received the same rate of dividend. The
balance of the dividends, if any, should be divided pro rata based on the capital balances (Abeleda, 2012).

CASE 4. The preference shares are cumulative and fully participating


Dividends Preferences Ordinary
Total dividends declared 1,500,000
Past preference dividends (12% x 2,000,000 x 2) (480,000) 480,000
Current preference dividends (240,000) 240,000
Ordinary dividends (720,000) 720,000
Balance: Pro rata (60,000) 45,000
Distribution of dividends 0 735,000 765,000
Divide by outstanding shares 40,000 200,000
Dividends per share P 18.375 P 3.825

Because the preference shares are cumulative, three (3) years’ worth of dividends are paid; but before the
preference shareholders can participate (pro rata) in the balance of the dividends declared, the ordinary
shareholders should also be paid first with the same rate of dividend (Abeleda, 2012).

CASE 5. The preference shares are cumulative and participating only up to 14%
Dividends Preferences Ordinary
Total dividends declared 1,500,000
Past preference dividends (12% x 2,000,000 x 2) (480,000) 480,000
Current preference dividends (240,000) 240,000
Ordinary dividends (720,000) 720,000
Balance 60,000
Addt’l. 2% for preference shares (2,000,000 x 2%) (40,000) 40,000
Balance to ordinary shares 20,000
Ordinary dividends (20,000) 20,000
Distribution of dividends 0 760,000 740,000
Divide by outstanding shares 40,000 200,000
Dividends per share P 19.00 P 3.70

Because the preference shares are cumulative, three (3) years’ worth of dividends are paid. However,
before the preference shareholders can get the additional 2% participation, the ordinary shareholders
should first be paid with the same rate of 12% (Abeleda, 2012).

Accounting for Retained Earnings

Retained Earnings are the earnings which are not yet distributed as dividends and are accumulated by the
corporation over a period of time (as of a given Balance Sheet date). A credit balance is always accounted for
Retained Earnings, though this amount is added to the total contributed share capital to arrive at the total
shareholders’ equity as of a given Balance Sheet date. If a retained earning has a debit balance due to
accumulated losses or other factors, it is appropriately called deficit. This will be deducted from the total share
capital contributed. The deficit must be termed as Capital Deficiency rather than Shareholders’ Capital if it will
exceed the paid in capital (Abeleda, 2012).

The following are the factors or transactions affecting Retained Earnings account (Abeleda, 2012):
• Periodic net income or loss. All nominal accounts (revenue and expense accounts) will be closed to the
Income & Expense Summary account at the end of each accounting period (usually one [1] year). Net
income will arise after the closing entries and the account will show a credit balance. A net loss will result if
it is a debit balance.

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The balance of the Income & Expense Summary account is then closed to the Retained Earnings account
as shown below:

If there is a net income: If there is a net loss:


Income & Expense Summary xxx Retained Earnings xxx
Retained Earnings xxx Income & Expense Summary xxx

• Dividends declared out of earnings. Inasmuch as the dividends to be distributed to the shareholders will
come from the retained earnings, the effect of the dividend declaration would be to reduce the balance of
the retained earnings and the total shareholders’ equity. The pro forma entry to record the declaration of
dividend is as follows:

Retained Earnings xxx


Dividends Payable xxx

• Adjustments of prior years’ profits. Errors in recording business transactions are normal and
unavoidable. If the error affects a nominal account, then the net income will be affected; and if not corrected
in the current year, the retained earnings will be misstated. An adjustment of the retained earnings will be
required if any misstatement (under or overstated amount) was discovered prior to the years’ profits.
Misstatement may result from mathematical errors, omission of certain transactions, or erroneous
applications of accounting principles.

Illustration: Last year, the depreciation expense was understated by P3,000.

Retained Earnings xxx


Accumulated Depreciation xxx
The correction of prior year’s profits will be taken up in detail in the higher accounting subjects.

• Recapitalization. This simply means changing the capital structure of a corporation. Typical types of
recapitalization are as follows:
o Change from no par value to par value share capital.

Assume the following Shareholders’ Equity:


Share Capital, P10 stated value, issued 100,000 shares P 1,000,000
Share Capital in Excess of Stated Value 45,000
Retained Earnings 480,000
Treasury Shares (2,000 shares) – at cost (25,000)
P 1,500,000

Case 1. All issued and outstanding shares are called in for cancellation and exchanged for 100,000
shares of P12 par value share capital.

Share Capital (old) 1,000,000


Share Capital in Excess of Stated Value 45,000
Retained Earnings 180,000
Share Capital (new) (100,000 x 12) 1,200,000
Treasury Shares 25,000

Case 2. All issued and outstanding shares are called in for cancellation and exchanged for 100,000
shares of P8 par value share capital.

Share Capital (old) 1,000,000


Share Capital in Excess of Stated Value 45,000
Share Capital (new) (100,000 x 8) 800,000
Treasury Shares 25,000
Share Capital from Change to Par Value 220,000

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o Change from par value to no par value share capital.

Assume the following Shareholders’ Equity:


Share Capital, P100 par value, issued 10,000 shares P 1,000,000
Share Premium 125,000
Retained Earnings 250,000
Treasury Shares (500 shares) – at cost (60,000)
P 1,315,000

Case 1. All issued and outstanding shares are called in for cancellation and exchanged for 10,000
shares of no par with a stated value P120 per share.

Share Capital (old) 1,000,000


Share Premium 125,000
Retained Earnings 135,000
Share Capital (new) (10,000 x 120) 1,200,000
Treasury Shares 60,000

Case 2. All issued and outstanding shares are called in for cancellation and exchanged for 10,000
shares of no par with a stated value P80 per share.

Share Capital (old) 1,000,000


Share Premium 125,000
Share Capital (new) (100,000 x 8) 800,000
Share Capital from Change to Par Value 265,000
Treasury Shares 60,000

o Change in the amount of par value or stated value.

Change in Par Value. Assume the following Shareholders’ Equity:


Share Capital, P100 par value, issued 10,000 shares P 1,000,000
Share Premium 350,000
Retained Earnings 250,000
P 1,600,000

Case 1: The par value was reduced from P100 to P90 per share.

Share Capital (10,000 x 10) 100,000


Share Capital from Reduction of Par Value 100,000

Case 2: The par value was increased from P100 to P120 per share.

Share Premium (10,000 x 20) 200,000


Share Capital 200,000

Change in Stated Value. Assume the following Shareholders’ Equity:


Share Capital, P20 stated value, issued 100,000 shares P 2,000,000
Share Capital in Excess of Stated Value 450,000
Retained Earnings 550,000
P 3,000,000
Case 1: The stated value was reduced from P20 to P18 per share.
Share Capital (100,000 x 2) 200,000
Share Capital from Reduction of Stated Value 200,000

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Case 2: The stated value was increased from P20 to P22 per share.

Share Capital in Excess of Stated Value 200,000


Share Capital 200,000

o Share splits (Split up or split down). Share split simply means that the total amount of paid in capital
must remain unchanged by increasing or decreasing the number of shares originally issued within a
corresponding increase or decrease in the par or stated value.

Two (2) types of share split:


 Share Split-up. An original share issued is cancelled and will be replaced by a larger number of
shares accompanied by a reduction in the par or stated value per share. To stimulate the sale of
the share capital, this is resorted to by the corporation.
 Share Split-down (Reverse Share Split). An original share issued is cancelled and will be
replaced by a smaller number of shares accompanied by an increase in the par or stated value per
share. To minimize the number of shareholders, this is resorted to by the corporation. There is no
entry required for share splits in the general journal. However, a memo entry is made instead in the
general ledger under the account title Share Capital as illustrated:

Share Capital
Authorized 50,000 shares with par value of P100 per share, issued 10,000 shares
P1,000,000
Note: Issued 20,000 new shares with par value of P50 per share to replace
the 10,000 old shares
Using the above example, it will be noted that the total value of the share capital remains the same
before and after the share split.

Before the share split (10,000 x 100) P 1,000,000


After the share split (20,000 x 50) P 1,000,000

 Conversion of preference share into ordinary share. If preference share is convertible, it can be
converted into other securities of the corporation (usually ordinary share) at the option of the holder.
This type of share capital is usually sold at a higher price but a lower dividend rate because of the
conversion privilege.

All accounts relating to the Preference Share must be closed (debited) to record the conversion of
the preference share into ordinary share capital and the Ordinary Share Capital account will be
credited. Any gain on conversion is credited to Share Capital from Conversion of Preference Share
account and any loss is charged to Retained Earnings account.

Illustration: Assume the following Shareholders’ Equity:


12% Preference Share Capital, par P50, 10,000 shares issued P 500,000
Ordinary Share Capital, par P20, 15,000 shares issued 300,000
Preference Share Premium 50,000
Ordinary Share Premium 60,000
Retained Earnings 290,000
P 1,290,000

On this date, 2,000 shares of preference shares were converted into ordinary shares.

Case 1: Four (4) ordinary shares were issued for every preference share:

Preference Share Capital (2,000 x 50) 100,000


Preference Share Premium (50,000/500,000 x 100,000) 10,000
Retained Earnings (bal. fig.) 50,000
Ordinary Share Capital (2,000 x 4 x 20) 160,000

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Case 2: Two (2) ordinary shares were issued for every preference share:

Preference Share Capital (2,000 x 50) 100,000


Preference Share Premium (50,000/500,000 x 100,000) 10,000
Ordinary Share Capital (2,000 x 4 x 20) 80,000
Share Capital from Conversion of Preference Share 30,000

• Quasi-reorganization. The procedure of restating (revaluing) the assets, liabilities, and capital balances
(of a financially distressed company) based on their market values is called quasi-reorganization. Financially
troubled companies may have a fresh start by eliminating a deficit and may be able to recover.

Quasi-reorganization may be accomplished through recapitalization and/or revaluation of fixed assets


subject to the approval of the shareholders and the Securities and Exchange Commission (SEC).

If the current market values are substantially more than their historical costs, the revaluation of properties
and equipment is allowed. A difference will be credited to Revaluation Increment account which will be
shown in the Balance Sheet as an addition to Shareholder’s Equity. This topic will be discussed in detail in
the higher accounting subject.

Appropriation of Retained Earnings means a portion of retained earnings is set aside for a specific purpose.
A fixed amount of retained earnings is accomplished by transferring a separate account, which is Appropriated
Retained Earnings, to a fixed amount of retained amount of retained earnings. Retained Earnings account will
be classified into Appropriated Retained Earnings and Unappropriated Retained Earnings (free) without
changing the total amount (Abeleda, 2012). The presentation of the Retained Earnings in a Balance Sheet
under the caption Shareholders’ Equity (all figures assumed) is as follows:

Share Capital, par P100, issued 20,000 shares P 2,000,000


Share Premium 150,000
Retained Earnings:
Unappropriated (Free) P 100,000
Appropriated for ? 80,000 180,000
Total Shareholders’ Equity P 2,330,000

It should be noted that the appropriation of the retained earnings restricts the amount of dividends which can
be declared. Using the figures, P180,000 is available for dividends if no appropriation is made; but with the
appropriation, only P100,000 can be declared as dividends.

Retained Earnings may be appropriated for any of the following purposes (Abeleda, 2012):
• Appropriation for future contingency such as a pending lawsuit where the company is the defendant
• Appropriation for plant expansion such as future construction of building
• Appropriation for an increase in working capital
• Appropriation for acquisition of treasury shares
• Appropriation for the creation of a sinking fund (a fund created for the purpose of paying the bonds payable
upon maturity)
• Appropriation for any other purpose which the company may deem necessary.

The pro forma journal entry to record the appropriation is as follows:

Retained Earnings xxx


Appropriated for ? xxx

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When the purpose for the appropriation has been achieved, the entry to record the appropriation should be
reversed as follows:

Appropriated for ? xxx


Retained Earnings xxx

Note: If the appropriation is for the acquisition of Treasury Shares, the entry to record the appropriation is
reversed only after the Treasury Shares are reissued or retired.

Statement of Retained Earnings. A separate Statement of Retained Earnings must be prepared to supplement
the Balance Sheet under the Financial Reporting Standards Council or FRSC (formerly known as Accounting
Standards Council [ASC]) guidelines on financial statements presentation. This statement will show the changes
in the Retained Earnings account in detail.

An example of the Statement of Retained Earnings (with assumed figures) is presented:

MAC CORPORATION
Statement of Retained Earnings
Year Ended December 31, 200D

Retained Earnings, January 1 P 400,000


Prior period adjustment:
Over depreciation of assets in 200C 100,000
Adjusted retained earnings, January 1 P 500,000
Add: Net income for 200D P 600,000
Reversal of appropriated retained earnings 100,000 700,000
Total P 1,200,000
Less: Cash dividends declared 400,000
Appropriated for plant expansion 90,000
Appropriated for treasury shares 30,000 520,000
Unappropriated Retained Earnings, December 31 P 680,000

The Retained Earnings account will appear in the Shareholders’ Equity Section of the Balance Sheet as follows:

Share Capital xxxxxxxxxx


Share Premium xxxxxxxxxx
Retained Earnings:
Unappropriated (free) P 680,000
Appropriated for plant expansion 90,000
Appropriated for treasury shares 30,000 800,000
Total Shareholders’ Equity xxxxxxxxxx

Book Value and Earnings per Share

Book Value Per Share

Book value per share refers to the peso equivalent of the net assets (assets less liabilities) or the total
shareholders’ equity expressed on a per share basis.

The book value per share computation assumes that the corporation will be liquidated and that the assets can
be sold at their book values (no gain or loss on realization).

This is of great interest and importance not only to the management of a corporation but also to the present and
prospective shareholders. The shareholders would like to find out from time to time (usually every Balance

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Sheet date) how much is the value of each share capital they own (status of their investment) as a basis for
determining the market price.
It becomes more meaningful if it is compared with the par or stated value per share. A very high book value per
share in relation to the par or stated value is a good indicator of the corporate stability and or profitability. If there
is only one (1) class of share capital issued (assumed to be an ordinary share), the book value per share is
computed as follows:

𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 =
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Illustration: Assume the following Shareholders’ Equity of X Corporation:

Share Capital, P100 par value P 4,000,000


Share Premium 400,000
Retained Earnings:
Unappropriated P 250,000
Appropriated for Plant Expansion 350,000 600,000
Total Shareholders’ Equity P5,000,000

The book value per share is computed as follows:

𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑃𝑃5,000,000


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 = = = 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 𝒑𝒑𝒑𝒑𝒑𝒑 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

When there are two (2) share capital issued, preference and ordinary share, the computation must give
recognition to the special rights and privileges of the preference share similar to the computation of the dividends
per share.

𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑜𝑜𝑜𝑜 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 =
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑜𝑜𝑜𝑜 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑦𝑦 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 =
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Earnings Per Share

Earnings per share are the corporation’s net earnings for a given period (usually one [1] year) translated into
a per share basis of the ordinary share capital. This is a net income expressed on a per share basis for a better
appreciation of the profitability of the ordinary shares.

Illustration: Assume that the net income of a corporation for the year just ended is P500,000 and there are
40,000 ordinary shares outstanding with a par value of P40 per share and a market value of P50 per share.

𝑃𝑃500,000
𝐸𝐸𝐸𝐸𝐸𝐸 = = 𝑃𝑃12.50 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

To be more significant or meaningful, the EPS can be related to the market value to determine the relative
profitability of buying ordinary shares.

𝑃𝑃12.50
= 25% 𝑅𝑅𝑅𝑅𝑅𝑅 (𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑜𝑜𝑜𝑜 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼)
𝑃𝑃50.00

If all the earnings will be declared as dividends, then the prospective shareholders will get 25% of their holdings.

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It should be noted that the EPS is applicable only to a corporation because a sole proprietorship or a partnership
does not have shares of stock or share capital. Also, EPS is computed only for the ordinary share because its
dividend will vary from period to period, depending on the amount of net earnings, unlike in the case of the
preference share which has a fixed dividend per share regardless of the net income.

The EPS should be disclosed in the Income Statement just below the final net income. Some reasons why EPS
is useful to management and other interested parties are the following:
• It can be used to evaluate the earning potential of a corporation
• It can be used as a market price determinant
• It can be used for formulating dividend policies.

Earnings per share (EPS) computation will depend on whether the capital structure of the corporation is simple
or complex.

Capital structure refers to the long-term liabilities plus the shareholder’s equity (Abeleda, 2012).
• Simple Capital Structure – one where the total shareholders’ equity consists of only ordinary shares.
Or, if there are other securities issued such as the preference shares or bonds payable, they are non-
convertible into ordinary shares (Abeleda, 2012).
• Complex Capital Structure – one where in addition to the ordinary shares, there are other potentially
dilutive securities (securities that will decrease the EPS because conversion of which into ordinary
shares will increase the outstanding shares). Examples of these securities are the convertible
preference shares or bonds (Abeleda, 2012).

Earnings per share have two (2) types, which can be computed according to the pronouncement of the
International Accounting Standards Committee (IASC) (Abeleda, 2012).
• Diluted Earnings per Share (DEPS) - this is applicable for Complex Capital Structure. This type will
be discussed in the higher accounting subjects.
• Basic Earnings per Share (BEPS) - this is applicable for Simple Capital Structure. This type will be
discussed on this topic.

If there is only one (1) class of share capital (ordinary share), the formula is:

𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 =
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑒𝑒𝑒𝑒 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Illustration 1: Mac Corporation has 5,000 ordinary shares outstanding with a par value of P100 per
share on December 31, 200B. The net income during the year is P1,000,000.

𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑃𝑃1,000,000


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = = 𝑃𝑃200 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑒𝑒𝑒𝑒 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 5,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Illustration 2: At the beginning of 200A, Mac Corporation had 2,000 ordinary shares outstanding. 400
additional shares were issued on April 1 and another 600 shares on August 1. The net income during
the year was P306,000.

𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑚𝑚𝑚𝑚 𝑃𝑃306,000


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = = 𝑃𝑃120 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑒𝑒𝑒𝑒 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 2,550 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
Because there were changes in the outstanding shares during the year, the denominator should be the
weighted average outstanding shares computed as follows:

Date Outstanding Shares Months unchanged Total


Jan. 1 2,000 x 3 = 6,000
Apr. 1 2,400 x 4 = 9,600
Aug. 1 3,000 x 5 = 15,000
12 30,600

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30,600
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑡𝑡𝑡𝑡𝑡𝑡 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 = = 2,550
12

If there are only two (2) classes of share capital (ordinary share), the formula is:

𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 =
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑒𝑒𝑒𝑒 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Illustration: Maclone Corporation showed the following share capital balances on December 31, 200E:

12% Preference Share Capital, P100 par, 10,000 shares issued and outstanding P 1,000,000
Ordinary Share Capital, P50 par, 40,000 shares issued and outstanding P 2,000,000
Net Income during the year P 1,000,000

Case 1: No dividends were declared during the year. The preference share is non-cumulative.

𝑃𝑃1,100,000
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = 𝑃𝑃27.50 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Since the preference share is non-cumulative and no dividends were declared during the year,
all the net income would be applied to the ordinary shares. Hence, the preference dividend
need not be subtracted from the net income.

Case 2: No dividends were declared during the year. The preference share is cumulative.

𝑃𝑃1,100,000 − (12% × 1,000,000)


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = 𝑃𝑃24.50 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Since the preference share is non-cumulative and no dividends were declared during the year,
all the net income would be applied to the ordinary shares. Hence, the preference dividend
need not be subtracted from the net income.

Case 3: Cash dividends were declared during the year. The preference share is non-cumulative. Same
as Case 2.

𝑃𝑃1,100,000 − (12% × 1,000,000)


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = 𝑃𝑃24.50 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Although the preference share is non-cumulative, the cash dividends were declared during the year;
hence, the preference dividend must likewise be subtracted from the net income.

Case 4: Cash dividends were declared during the year. The preference share is cumulative. Same as
Case 2.

𝑃𝑃1,100,000 − (12% × 1,000,000)


𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐸𝐸𝐸𝐸𝐸𝐸 = = 𝑃𝑃24.50 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎
40,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Because there were dividends declared during the year, the preference share dividends must be
subtracted from the net income regardless of the preference share being cumulative or not.

NOTE: The preference dividend is deducted from the net income only if there is a dividend declaration. If there
is no declaration of dividend, deduct only when the preference share is cumulative.

Shareholders’ Equity

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Shareholders’ equity is formerly called stockholders’ equity. Just like any other form of business organization, a
corporation has two (2) types of equity. These are the creditors’ equity (represented by the total liabilities) and
the shareholders’ equity (represented by the total capital of the shareholders) (Abeleda, 2012).

In reference to the Philippine Accounting Standards (PAS) and International Accounting Standards (IAS) #1,
the term “equity” without any qualification refers to the total shareholders’ equity. All the accounts will be shown
separately in the Statement of Changes in Equity as long as it affects the shareholders’ equity. This statement
will be discussed thoroughly in the higher accounting subject (Financial Accounting). A simple pro forma
Statement of Changes in Equity is shown on page 301 of the mandated book for reference (Abeleda, 2012).

Accounts and relevant disclosures that will appear in the Shareholders’ Equity section of the Balance Sheet
of a corporation are the following (Abeleda, 2012):
• Authorized Share Capital – A credit account that represents the total amount of share capital the
corporation is authorized to put up or the total shares authorized to be sold or issued expressed in pesos.
This account is valued at par value or stated value.
• Unissued Share Capital – A debit account, as the term implies, represents the share capital (stock
certificates) not yet issued because either the share capital is not yet sold or, if already sold, is not yet fully
paid hence still unissued. This account is also valued at par value or stated value. The Authorized Share
Capital and the Unissued Share Capital accounts are applicable only if the journal entry method is used for
recording the capital transactions. If the memo entry method is used instead, these will combine the two (2)
capital accounts into one (1) and call it Share Capital.
• Share Capital – A credit account that represents total issued and valued share capital (stock certificates)
at par or stated value (the subscription is fully paid). Memo entry method is used under this account.

Other accounts that will appear in the Shareholders’ Equity section of the Balance Sheet regardless of whether
the journal entry method or the memo entry method is used (Abeleda, 2012) are the following:
• Subscribed Share Capital – A credit account that represents the total subscriptions to the share capital
(capital stock) at par or stated value but not yet issued because they are not yet fully paid. This account is
closed upon full payment of the subscription.
• Subscriptions Receivable – A debit account that represents a portion of the subscribed share capital not
yet collected, hence the term receivable. The Subscriptions Receivable account is shown as a subtraction
from the Subscribed Share Capital account, and the net amount is added to the Issued Share Capital to get
the total Paid-in Share Capital or Paid-up Share Capital. However, if the subscription receivable has a call
date (date of collection) within one (1) year from the date of subscription, it will be shown under the caption
Current Assets in the Balance Sheet, in which case the Subscribed Share Capital account will be added to
the Issued Share Capital to arrive at the Outstanding Share Capital.
• Additional Share Capital Accounts
o Share Premium – A credit account that represents the excess of the subscription price of a par value
share capital over the par value.
o Share Capital in Excess of Stated Value – A credit account that represents the excess of the
subscription price of a no par value share capital over the stated value. Share Premium account is used
for a par value share capital to distinguish the excess of the subscription price over the par or stated
value, and Share Capital in Excess of Stated Value account is used for a no par value share capital.
o Share Capital from Donation – A credit account that represents donations received by the corporation
from private persons or from the local or foreign government.
o Treasury Share Premium – A credit account that represents the gain on the reissue of treasury shares.
o Share Capital from Retirement of Treasury Shares – A credit account that represents the gain on
retirement of treasury shares.
o Share Capital from Stock Dividend – A credit account that represents the excess of the fair market
value of the share capital on the date of dividend declaration over the par value or stated value.
o Share Capital from Change of Par to No Par Value – A credit account that represents the difference
between par value and the replaced stated value of the share capital.
o Share Capital from Change of No Par to Par Value – A credit account that represents the difference
between the stated value and the replaced par value of the share capital.
o Share Capital from Reduction of Par or Stated Value – A credit account that represents the
difference between the original par or stated value and the new par or stated value.

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o Share Capital from Conversion of Preference into Ordinary Share – A credit account that
represents the excess of the aggregate par or stated value of the preference shares over the par or
stated value of the ordinary shares.
• Stock Dividends Distributable – A credit account that represents the additional share capital to be issued
as a result of stock dividend declaration but not yet distributed as of the Balance Sheet date. This will be
presented below the Total Contributed Capital. If there are two (2) classes of share capital being issued,
which are preference and ordinary shares, they must be clearly specified in the different shareholders’
accounts mentioned above to distinguish one (1) class of stock from the other.
• Retained Earnings – A credit account that represents the corporation’s cumulative earnings. It is classified
into the following:
o Unappropriated Retained Earnings – the portion of the total retained earnings which is available for
dividend distribution. The other terms for this are “unrestricted” or “free” retained earnings.
o Appropriated Retained Earnings – the portion of the total retained earnings appropriated for future
contingencies or specific purposes, hence cannot be declared as dividends.
The Retained Earnings account is presented in the Shareholders’ Equity as an addition to the Total
Contributed Capital.
• Revaluation Increment – A credit that represents the excess of the appraised value of the property, plant,
or equipment over the historical cost. This is presented right below the Retained Earnings as an addition to
the Shareholders’ Equity.
• Treasury Shares – A debit account that represents the corporation’s own share capital (capital stock)
previously issued and later acquired back but not yet reissued or retired. It is not entitled to a dividend
because this stock (share capital) is no longer in the hands of the shareholder. (A corporation cannot
distribute dividend to itself.)

Illustration:
• One (1) class of share capital (using the journal entry method). The Subscriptions Receivable account is
collectible within one (1) year.

Shareholders’ Equity
Authorized Share Capital, 50,000 shares, P100 par P 5,000,000
Less: Unissued Share Capital 2,000,000
Issued Share Capital P 3,000,000
Subscribed Share Capital (5,000 shares) 500,000
Additional Share Capital:
Share Premium P 200,000
Share Capital from Donation 250,000
Treasury Share Premium 25,000
Share Capital from Stock Dividend 85,000 560,000
Stock Dividends Distributable (3,000 shares) 300,000
Total Share Capital Contributed P 4,360,000
Retained Earnings:
Unappropriated P 385,000
Appropriated for Sinking Fund 700,000
Appropriated for Building Expansion 200,000
Appropriated for Treasury Shares 215,000 1,500,000
Revaluation Increment 245,000
Total P 6,105,000
Less: Treasury Shares (at cost) 215,000
TOTAL SHAREHOLDERS’ EQUITY P 5,890,000
The Subscription Receivable account will be presented instead in the Balance Sheet under the caption
Current Assets. It should be noted that as a result of the different treatment of the Subscriptions Receivable
account, the total Shareholders’ Equity increased by P100,000 with a corresponding increase by the same
amount in the total current assets (Abeleda, 2012).

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• Using the International Accounting Standards (IAS) recommendation.

Shareholders’ Equity
Share Capital, 50,000 shares authorized, P100 par,
30,000 shares issued of which 2,000 shares are in
the treasury P 3,000,000
Subscribed Share Capital 500,000
Stock Dividends Distributable (3,000 shares) 300,000
Total Contributed Share Capital P 3,800,000
Add: Reserves:
Share Premium P 200,000
Share Capital from Donation 250,000
Treasury Share Premium 25,000
Share Capital from Stock Dividend 85,000
Appropriated for Sinking Fund 700,000
Appropriated for Building Expansion 200,000
Appropriated for Treasury Shares 215,000
Revaluation Increment 245,000 1,920,000
Retained Earnings: 385,000
Total P 6,105,000
Less: Treasury Shares (at cost) 215,000
TOTAL SHAREHOLDERS’ EQUITY P 5,890,000

It should be noted that under the International Accounting Standards (IAS) recommendation, included in
the caption Reserves are all the Additional Share Capital accounts, and all the appropriations to the
Retained Earnings account as well as the Revaluation Increment account.

Incorporation of a Sole Proprietorship or Partnership

Nature of Incorporation

Incorporation means setting up or forming a corporation. In sole proprietorship or partnership, incorporation


simply means converting the business into a corporate form of organization. The sole proprietorship or
partnership will be dissolved and the newly converted corporation will continue the operations of the business
(Abeleda, 2012).

The Articles of Incorporation and the Corporate By-Laws will be filed by the owner or partners, together with
other incorporators and with the Securities and Exchange Commission (SEC), to formally convert the business
into a corporation. The corporation will issue the corresponding stock certificates to the owner or partners for
the net assets (assets less liabilities) to be transferred to the new corporation in payment of the subscription of
the owner or partners to the share capital. In the case of partnership, the partners will be issued stock certificates
in proportion to their capital balances on the date of incorporation (Abeleda, 2012).

Accounting Procedures for Incorporation

In the event that a sole proprietorship or partnership will be converted into a corporation, essentially, new set of
books will be used. The following accounting procedures must be followed (Abeleda, 2012):

• In the Books of the Sole Proprietorship or Partnership

o The net income (after the necessary adjusting entries to update the records) will be determined on the
date of incorporation by closing all nominal accounts to the Income & Expense Summary account.
o The balance of the Income & Expense Summary account will be transferred to the capital account of
the owner—or in the case of proprietorship, to the capital accounts of the partners using their agreed
profit and loss ratio.

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o The asset accounts will be adjusted based on their market values with corresponding adjustments to
the capital/s of the owner or partners.
o The adjusted net assets of the business will be transferred in the books of the new corporation (closing
entry) in exchange for the stock certificates received by the owner or partners by debiting an Investment
in Stock account, assuming all the liabilities, all the contra asset accounts, and all the asset accounts
are credited.
o The capital account/s of the owner or partners will be closed by debiting the capital account/s and
crediting the Investment in Stock account.

• In the Books of the Corporation

Record the approval by the Securities and Exchange Commission (SEC) of the authorized share capital,
then record the issuance of the share capital to the owner or partners in exchange for the net assets
transferred by debiting the assets and crediting the liabilities to be assumed as well as the contra asset
accounts and the share capital accounts.

References:
Abeleda, N. S. (2012). Simplified accounting for partnership and corporation. Parañaque: Nelson Publications.
Horngren, C. T., Harrison Jr., W. T., & Oliver, M. (2012). Accounting (9th Ed.). Upper Saddle River, New Jersey:
Prentice Hall.
Needles, B. E., Powers, M., & Crosson, S. V. (2014). Principles of accounting. The United States of America:
Cengage Learning.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Accounting principles (12th Ed.). The United States of
America: John Wiley & Sons, Inc.

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