SHAREHOLDERS’ EQUITY

Related standard: PAS 32 Financial Instruments: Presentation

Learning Competencies
• State the components of shareholders’ equity.
• Account for the initial issuances of shares of stocks.
• Account for the reacquisition and retirement of shares of
stocks.
• Account for stock rights, convertible preference shares
and donated capital.
• Account for distribution to owners
• Account for recapitalization and quasi-reorganization
• The Philippine Corporation Code defines a corporation as “an
artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly
authorized by law or incident to its existence.”
• A corporation is formed by at least 5 but not exceeding 15
natural persons, all of legal age and a majority of whom are
residents of the Philippines.
• The entity’s articles of incorporation must be authorized by the
Securities and Exchange Commission (SEC).
• The articles of incorporation states, among other things, the
entity’s authorized capital stock, which is the maximum
number of shares that the entity can issue. Any excess share
issued is deemed illegal. In order to issue shares in excess of
the authorized capital stock, the entity must amend its articles
of incorporation.
• To amend the articles of incorporation, a majority vote of the
board plus a vote by shareholders representing at least two-
thirds (2/3) of the outstanding share capital is needed. After
ratification, the amended articles of incorporation are filed
with the SEC and shall become effective only upon approval
by the SEC.
• At least 25% of the entity’s authorized capitalization should
be subscribed and at least 25% of the total subscription must
be paid upon subscription. In no case shall the paid-up capital
be less than five thousand pesos (₱5,000).
COMPONENTS OF STOCKHOLDERS’
EQUITY
The following transactions affect the accounting for a
corporation’s equity:
1. Authorization, subscription, issuance, acquisition,
reissuance and retirement of shares
2. Origination of other equity instruments, such as share
options, detachable warrants, and equity component of
compound financial instruments.
3. Distributions to owners
4. Transactions giving rise to “other components of equity”
5. Recapitalization and Quasi-reorganization
 ACCOUNTING FOR SHARE
CAPITAL

Memorandum method - Only a memorandum is made

for the authorized capitalization. Subsequent issuances of
shares are credited to the share capital account.

Journal entry method - The authorized capitalization is

recorded by crediting “authorized share capital” and
debiting “unissued share capital.” Subsequent issuances
of shares are credited to “unissued share capital.”
AUTHORIZED SHARE CAPITAL – represents the
maximum number of shares fixed in the entity’s
authorized articles of incorporation that can be
subscribed and issued to shareholders.

UNISSUED SHARE CAPITAL – represents the

portion of the authorized share capital not yet issued
and still available for subscription and issuance.
 CLASSES OF SHARE CAPITAL

Share capital is basically classified into two, namely:

1. Ordinary share capital (common stock); and

2. Preference share capital (preferred stock).
ORDINARY SHARE CAPITAL
This represents the residual corporate interest that
bears ultimate risk of loss and receives the benefits
of the corporation.
 FOUR BASIC RIGHTS OF
ORDINARY SHAREHOLDERS
1. Right to attend and vote in shareholders’ meetings
2. Right to purchase additional shares (also known as
preemptive right or stock right)
3. Right to share in the corporate profits (also known as
right to dividends)
4. Right to share in the net assets of the corporation
upon liquidation
PREFERENCE SHARE CAPITAL
These are shares that give the holders certain
preferences over other shareholders.

The preferences may include priority claims over:

1. Dividends and/or;
2. Net assets of the corporation in the event of
liquidation.

In exchange for such preferences, shareholders sacrifice

certain inherent rights of ordinary shareholders. (e.g.
voting rights)
 SHARE PREMIUM

Share premium (additional paid-in capital) arises from various

sources which include the following:
1. Excess of subscription price over par value or stated value.
2. Excess of reissuance price over cost of treasury shares issued.
3. Issuance or origination of other equity instruments, such as
share options, detachable share warrants, and equity
components of compound financial instruments.
4. Distribution of “small” stock dividends.
5. Quasi-reorganization and recapitalization.
 LEGAL CAPITAL
Legal capital is the portion of contributed capital that cannot be
distributed to the owners during the lifetime of the corporation unless
the corporation is dissolved and all of its liabilities are settled first.
Legal capital is computed as follows:
1. For par value shares, legal capital is the aggregate par value of
shares issued and subscribed.
2. For no-par value shares, legal capital is the total consideration
received or receivable from shares issued or subscribed. Total
consideration refers to the subscription price inclusive of any amount
in excess of stated value.
 SHARE ISSUANCE COSTS
These are expenses, such as regulatory fees, legal, accounting
and other professional fees, commissions and underwriter’s
fees, printing costs of certificates and documentary stamp tax
and other transaction taxes.
“The transaction costs of an equity transaction are accounted
for as a deduction from equity to the extent they are
incremental costs directly attributable to the equity
transaction that otherwise would have been avoided.” (PAS
32.7)
These expenditures are deducted from any resulting share
premium from the issuance. If the share premium is
insufficient, the expenses are charged to Retained Earnings.
 TREASURY SHARES

Treasury shares (treasury stocks) are an entity’s

own shares that were previously issued but are
subsequently reacquired but not retired. Under
the Corporation Code, an entity may reacquire
its previously issued shares only if it has
sufficient unrestricted retained earnings.
 ACCOUNTING FOR TREASURY
SHARES

The cost method is used in accounting for treasury

share transactions. Under this method, the
reacquisition and subsequent reissuance of treasury
shares are recognized and derecognized,
respectively, at cost.
RETIREMENT OF SHARES
 STOCK RIGHTS
Stock rights are issued to existing ordinary shareholders in
relation to their preemptive rights. The stock rights enable
existing shareholders to protect their current ownership
interests by acquiring new shares issued by the corporation
before such shares are offered to new investors.

Stock rights are recorded through memo entry only because

stock rights are issued to existing shareholders without
consideration. An entry is made only when the rights are
exercised or recalled.
 DONATED CAPITAL

Donation from shareholders – recognized directly in equity

(i.e., credited to share premium).
Donation from the government – recognized as government
grant
Donation from other sources – recognized in profit or loss
(i.e., income) when (a) the conditions attached to the
donation are fulfilled or reasonably expected to be fulfilled,
(b) the donation becomes receivable, and (c) the criteria for
asset recognition is met.
Cash – recognized at the amount of cash received or
receivable.
Noncash assets – recognized at the fair value of the noncash
assets
Entity’s own shares – initially recorded through memo
entry. Donated capital is recognized only when the donated
shares are subsequently reissued. This is because no asset is
generated from the donated shares until they are
subsequently reissued. If the donated shares are not to be
resold, the entity should effect a formal reduction of its
authorized capital by retiring the shares received.
 RETAINED EARNINGS
Retained earnings represent the cumulative profits (net of
losses, distribution to owners, and other adjustments) which
are not yet distributed as dividends but rather retained to be
reinvested in the business or to settle debt.

Total retained earnings may consist of:

1. Unrestricted – available for future distribution as
dividends
2. Appropriated (Restricted) – not available for distribution
unless the restriction is subsequently reversed.
DISTRIBUTION OF DIVIDENDS

1. Cash dividends – distributions in the form of cash.

• Liability dividends – are dividends issued by a corporation
that has a temporary cash shortage. Liability dividends may
be either:
• Scrip dividends – short-term and may or may not bear interest
• Bond dividends – long-term and bear interest
2. Property dividends – distributions in the form of noncash
assets.
3. Share dividends (bonus issue or stock dividends) –
distributions in the form of the entity’s own shares.
 DATES RELEVANT TO THE
ACCOUNTING FOR DIVIDENDS
1. Date of declaration
2. Date of record
• Ex-dividend date – to provide shareholders ample time
to register, they are normally allowed to register about
three to five days prior to the date of record.
3. Date of distribution – the date when the dividends declared
are distributed to the shareholders who are entitled to the
dividends.
RECOGNITION OF LIABILITY FOR
DIVIDENDS
Under IFRIC 17, the liability to pay a dividend shall be recognized
when the dividend is appropriately authorized and is no longer at
the discretion of the entity, which is:
1. The date when the dividend declared by management is
approved by a relevant authority, if further approval is
required, or
2. The date when management declares dividends, if further
approval is not required.
Outstanding shares pertain to shares issued and held by shareholders
and those that are subscribed. Outstanding shares exclude unissued
shares and treasury shares.
 ACCOUNTING FOR CASH
DIVIDENDS
Cash dividends are the most common form of
distribution to owners. Cash dividends may be declared
as a certain amount per share or as a certain percentage
of the par value of the shares.
 ACCOUNTING FOR PROPERTY
DIVIDENDS

The accounting for property dividends is affected by the

following:

1. Accounting for the resulting property dividends payable,

and
2. Accounting for the non-cash assets declared as property
dividends
The liability recognized on the declaration of property
dividends is accounted for as follows:
1. The property dividends payable is initially measured at
the fair value of the non-cash assets at date of
declaration.
2. At the end of each reporting period and also on the
settlement date, the property dividends payable is
adjusted for changes in fair value. The changes are
recognized as gain or loss, directly in retained earnings.
3. On settlement (distribution) date, any difference between
the carrying amounts of the dividends payable and the
asset distributed is recognized in profit or loss.
 Accounting for non-cash assets declared as property
dividends

If the property dividend is a noncurrent asset, it shall be,

subject to the requirements of PFRS 5, reclassified as “Non-
current asset held for distribution to owners” and
subsequently accounted for under PFRS 5. A “Non-current
asset held for distribution to owners” is initially and
subsequently measured at the lower of its carrying amount
and fair value less costs to distribute.

If the property dividend is a current asset, it shall be

accounted for under its previous accounting. No
reclassification is needed.
 SHARE DIVIDENDS

If the share dividends declared are considered “small” share

dividends (i.e., less than 20% of the outstanding shares), the
share dividends are accounted for at fair value.

If share dividends declared are considered “large” share

dividends (i.e., 20% or more of the outstanding shares), the
shares are accounted for at par value.
 PREFERENCE SHARES

Preference shares have one or both of the following

preferences over ordinary shares:

1. Preference in the distribution of assets in case of corporate

liquidation (preferred as to assets)
2. Preference in the distribution of dividends when declared
(preferred as to dividends)
 Preference in the distribution of assets in case of
corporate liquidation (preferred as to assets)

During liquidation, preference shares that are preferred as to

assets are settled first. Any remaining amount is paid to
ordinary shareholders.

If the preference share are not preferred as to assets, the

remaining amount after paying the liabilities are shared
proportionately by the preferred and ordinary shareholders.
 Preference in the distribution of dividends when declared
(preferred as to dividends)

When dividends are declared, preference shares that are “preferred as to

dividends” are paid first before ordinary shareholders.

Preference over dividends may be:

1. Noncumulative – a non cumulative preference share is one which the

dividend entitlement for a year is forfeited when dividends are not
declared in that year.
2. Cumulative – a cumulative preference share is one which the dividend
entitlement accumulates each year until paid. Accumulated unpaid
dividends are disclosed as “dividends in arrears” but not accrued as a
liability unless the dividends are declared.
3. Non participating – a non participating preference share is one which
is entitled only to a fixed amount of dividends.
4. Participating – a participating preference share is one which is entitled
to an amount in excess of the fixed amount of dividends.
 DIVIDENDS RECOGNIZED AS
EXPENSE

Dividends declared on equity instruments are charged

to retained earnings. However, dividends declared on
financial liabilities, such as redeemable preference
shares, are charged to profit or loss as interest
expense.
DIVIDENDS OUT OF CAPITAL

Dividends declared out of capital, rather than from retained

earnings, are called liquidating dividends. Liquidating
dividends are normally declared only upon corporate
liquidation. However, the wasting asset doctrine permits
wasting asset corporations to declare dividends out of capital
during their existence.
 DISCLOSURE OF DIVIDENDS

Dividends declared and the related amount per share are

presented either in the statement of changes in equity or in
the notes.

Dividends declared after the reporting period but before the

financial statements are authorized for issue are not
recognized as a liability at the end of the reporting period
because no obligation exists at that time. The dividends are
disclosed only in the notes.
OTHER COMPONENTS OF EQUITY

1. Revaluation surplus
2. Cumulative unrealized gains/losses on fair value changes
in investments in FVOCI equity securities
3. Exchange differences on translating foreign operations
4. Effective portion of cash flow hedges
 RECAPITALIZATION
Recapitalization refers to the change in the capital structure of an
entity brought about by the cancellation of old shares and issuance of
new shares as replacement. Recapitalization is accomplished through
any of the following:
1. Change from par to no-par, or vice-versa
2. Reduction of par value or stated value
3. Share splits or reverse splits

Recapitalization does not affect assets, liabilities, or total

shareholders’ equity.
 SHARE SPLIT
1. Split up occurs when old shares are cancelled and replaced by a
larger number of new shares but with a reduced par value
(stated value) per share.
2. Split down is the opposite of split up whereby old shares are
cancelled and replaced by a smaller number of new shares but
with an increased par value (stated value) per share.
 QUASI-REORGANIZATION
Quasi-reorganization is an accounting procedure whereby a
financially troubled corporation, but with favorable future
prospects, is permitted, but not required, to revalue its assets and
liabilities, and realign its equity, subject to the provisions of
relevant regulations, in order to establish a “fresh start” in
accounting sense.
Quasi-reorganization may be effected through:
1. Revaluation of property, plant, and equipment; and/or
2. Recapitalization
The basic approach to quasi-reorganization is as follows:
1. Assets (and liabilities) are revalued upwards or
downwards.
2. Any resulting credit balance in revaluation surplus is used
to wipe out any deficit (i.e., negative balance in retained
earnings).
3. If a recapitalization is made, any resulting share premium
shall also be used to wipe out any deficit.
4. Disclosures required by relevant regulations are provided
in the financial statements for a minimum period of three
(3) years.