AUDIT OF SHAREHOLDERS’ EQUITY

Audit Objectives:
To determine:
1. Proper authorization of transaction involving shareholders’ equity accounts
2. Proper accounting treatment of transactions involving shareholders’ equity
3. Compliance with legal requirements related to corporate capitalization.
4. Propriety of financial statement presentation and adequacy of disclosures.

Audit Procedures:
1. Obtain a copy of the latest articles of incorporation and determine, for each class of share capital,
the:
 authorized share capital;
 par or stated value; and
 preferences and limitations, if any
2. Obtain a schedule of the share capital, subscribed share capital, and treasury share accounts
indicating the members of shares and amount for the:
 beginning-of-year balances;
 additions and deductions for the current year; and
 end-of-year balances
3. Foot and cross-foot the schedule
4. Verify accuracy of the schedule.
 Trace beginning balances to last year’s working papers or in case of an initial audit, establish
accuracy of beginning balances by:
 Test-tracing prior year’s recordings and supporting documents.
 Tracing beginning balances to general ledger balances
 Trace proceeds to cash receipts records for additional issues or subscriptions to share capital
and reissues of treasury shares.
 Trace payments for share capital retirements and acquisitions of treasury shares to cash
disbursements records and canceled checks.
 Agree working paper ending balances with the general ledger balances.
 Trace authorizations by reference to minutes of meetings of the board of directors and
shareholders.
5. Where the client is being serviced by an independent transfer agent or registrar:
 Confirm share capital issued and treasury shares
  Arrange for the inspection and count of treasury shares
6. Where the client does not maintain an independent transfer agent or registrar:
 Obtain from the corporate secretary a schedule of:
 Shareholders;
 subscribers;
 subscription receivable; and
 treasury shares
 Foot and cross-foot the schedule
 Test-trace to stock and transfer book
 Trace balances per schedule to general ledger balances
 Inspect and account for unissued, canceled, treasury share certificates
 Determine if the treasury shares had been properly endorsed in favor of the corporation
7. Confirm subscription receivable and consider collectability
8. Review articles of incorporation, by-laws, and minutes of meetings of the board of directors and
shareholders relating to share capital and related accounts.
9. Obtain schedules of other equity accounts, indicating:
 beginning-of-year balances;
 additions and deductions during the current year; and
 end-of-year balances
10. Foot and cross-foot the schedules.
11. Verify the accuracy of the schedules
 Trace beginning balances to last year’s working papers or, in case of an initial audit, establish
accuracy of beginning balances by:
 Test-tracing to prior year’s recordings and supporting documents
 Tracing beginning balances to general ledger balances
 For current year transactions:
 ascertain authorization; and
 determine propriety of accounting treatment
 Agree working paper ending balances with general ledger balances
12. Reconcile dividends paid to rates authorized in directors’ minutes of meetings.
13. Ascertain compliance with the requirements of the Securities and Exchange Commission (SEC) and
other regulatory bodies and contractual obligation relating to capitalization of retained earnings.
14. Determine propriety of financial statement presentation and adequacy of disclosure.
Concept of a corporation
A corporation is 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.
Organization cost
As the name suggests, the term “organization cost” represents costs incurred in forming or organizing a
corporation.
Specifically, organization costs include:
a. Legal fees in connection with the incorporation, such as drafting of articles of incorporation and
by-laws and corporation registration.
b. Incorporation fees
c. Share issuance costs, such as printing of stock certificates, cost of stock and transfer book, seal
of incorporation, underwriting and promotional fees, accounting and legal fees related to share
issuance.
Definition of terms
The terms “capital stock”, “common stock”, “preferred stock”, and “treasury stock” are the terms used
in our Philippine Corporation Code.
Capital stock or “share capital” is the portion of the paid in capital representing the total par or stated
value of the shares issued.
Subscribed share capital is the portion of the authorized share capital that has been subscribed but not
yet fully paid and therefore still unissued.
Additional paid in capital or “share premium” is the portion of the paid in capital representing excess
over the par or stated value.
Retained earnings represent the cumulative balance of periodic earnings, dividend distributions, prior
period errors and other capital adjustments.
Revaluation surplus is the excess of revalued amount over the carrying amount of the revalued asset.
Treasury shares are the corporation’s own shares that have been issued and then reacquired but not
canceled.
Capital stock
The term “capital stock” or “share capital” is the amount fixed in the articles of incorporation to be
subscribed and paid in or secured to be paid in by the shareholders of the corporation, either in money
or property or services, at the organization of the corporation, or afterwards and upon which the
corporation is to conduct its operation.
Actually, the amount fixed in the articles of incorporation is called the authorized share capital.
A par value share is one with specific value fixed in the articles of incorporation and appearing on the
share certificate. The purpose of the par value is to fix the minimum issue price of the share.
A no-par share is one without any value appearing on the face of the share certificate.
A share is simply called “no par” because it has no par value appearing on the face of the share
certificate. But a no-par share has always an “issued value” or “stated value” based on the consideration
for which it is issued.
The minimum consideration or issue price for no-par share as provided for in the Corporation Code is P5.
In other words, a no-par share cannot be issued for less than P5.
Ordinary share capital
Generally, the ordinary shares give the owner the right to vote, to share in the income, and in the event
of liquidation, to share in all assets after satisfying creditors and preference shareholders’ claims.
Preference share capital
The preferences usually pertain to the preference shareholders’ claims on dividends and net assets in
the event of liquidation.
Legal capital
Legal capital is that portion of the paid in capital arising from issuance of share capital which cannot be
returned to the shareholders in any form during the lifetime of the corporation.
Accounting for share capital
a. Memorandum method – No entry is made to record the authorized share capital. Only a
memorandum is made for the total authorized share capital.
When share capital is issued, it is credited to the share capital account.
b. Journal entry method – The authorization to issue share capital is recorded by debiting unissued
share capital and crediting authorized share capital.
Illustration – Memorandum method
1. An entity was authorized to issue share capital of P4,000,000 divided into 40,000 shares with par
value of P100.
Memo entry – The entity was authorized to share capital of P4,000,000, divided into
40,000 shares with par value of P100.
2. Received subscription to 10,000 shares at par.
Subscription receivable 1,000,000
Subscribed share capital 1,000,000
3. Collected 25% on the above subscription.
Cash 250,000
Subscription receivable 250,000
4. Received full payment for 6,000 shares originally subscribed.
Cash 450,000
Subscription receivable 450,000
Subscription price (6,000 x 100) 600,000
Less: Partial payment (25% x 600,000) 150,000
Balance 450,000
5. Issued the share certificates for 6,000 shares which are fully paid.
 Subscribed share capital 600,000
Share capital 600,000
The Corporation Code provides that shares are issued only when subscriptions are fully paid.
6. Received a cash subscription for 5,000 shares at par.
Cash 500,000
Share capital 500,000
Statement presentation
If a statement of financial position is prepared, the share capital would be shown under shareholders’
equity.
Share capital, P100 par, 40,000 shares authorized
11,000 shares issued 1,100,000
Subscribed share capital, 4,000 shares 400,000
Subscription receivable (300,000)
Shareholders’ equity 1,200,000
Illustration – Journal entry method
Assume the same information in the previous illustration.
1. Unissued share capital 4,000,000
Authorized share capital 4,000,000
2. Subscription receivable 1,000,000
Subscribed share capital 1,000,000
3. Cash 250,000
Subscription receivable 250,000
4. Cash 250,000
Subscription receivable 250,000
5. Subscribed share capital 600,000
Unissued share capital 600,000
Here lies the difference. The issuance of share capital is credited to the unissued share capital accounts.
6. Cash 500,000
Unissued share capital 500,000
Statement presentation
Authorized share capital, P100 par, 40,000 shares 4,000,000
Unissued share capital, 29,000 shares (2,900,000)
Issued share capital 1,100,000
Subscribed share capital, 4,000 shares 400,000
Subscription receivable (300,000)
Shareholders’ equity 1,200,000
Issuance of share capital
The Corporation Code provides that “a share shall not be issued for a consideration less than the par or
stated value thereof.”
The law further provides that shares without par value cannot be issued for less than P5.
When shares with par value are sold, the proceeds shall be credited to the share capital account to the
extent of the par value, with any excess being reflected as share premium.
For example, if 10,000 ordinary shares of P100 par value are sold at P150 per share, the journal entry is:
Cash 1,500,000
Ordinary share capital (10,000 x P100) 1,500,000
For example, if 20,000 ordinary shares of P50 stated value are issued at P80 per share, the journal entry
is:
Cash 1,600,000
Ordinary share capital (20,000 x P50) 1,000,000
Share premium 600,000
Definition
Retained earnings represent the cumulative balance of the following:
a. Net income or loss for the period
b. Dividend distributions
c. Prior period errors
d. Changes in accounting policy
e. Reclassifications of some components of other comprehensive income
f. Other capital adjustments
The IFRS term for retained earnings is “accumulated profits”.
However, the retained earnings account is used in succeeding illustrations.
The illustrative statement of financial position and statement of changes in equity in IAS 1 and IAS 8 still
maintain the title “retained earnings”.
Kinds of retained earnings
a. Unappropriated retained earnings
b. Appropriated retained earnings
Unappropriated retained earnings represent that portion which is free and can be declared as dividends
to shareholders.
Appropriated retained earnings represent that portion which has been restricted and therefore is not
available for any dividend declaration.
When the retained earnings account has a debit balance, it is called a “deficit”.
A deficit is not an asset but a deduction from shareholders’ equity.
The IFRS term for deficit is “accumulated losses”.
Simple illustration (all amounts are assumed)
Share Share Retained
capital premium earnings
Balance – January 1 5,000,000 2,000,000 1,000,000
Issuance share capital of 10,000 shares with
P100 par value at P150 per share 1,000,000 500,000
Net income 1,550,000
Dividend paid (200,000)
Balance – December 31 6,000,000 2,500,000 2,350,000

Comprehensive illustration (amounts are assumed)

Share Retained
capital Reserves earnings
Balance – January 1 5,000,000 2,000,000 1,000,000
Correction of error-prior year
under depreciation (100,000)
Change in accounting policy from
average to FIFO – credit 300,000
Issuance of 10,000 ordinary shares of P100
par value at P150 per share 1,000,000 500,000
Issuance of 5,000 preference shares of P50
par value at P150 per share 250,000 250,000
Comprehensive income:
Net income 1,550,000
Other comprehensive income 50,000
Dividends paid (400,000)
Current appropriation for contingencies 200,000 200,000
Balance – December 31 6,250,000 3,000,000 2,150,000