Chapter 20 Retained earnings appropriated / Appropriation

reserve
Shareholders’ Equity
Revaluation surplus / Revaluation reserve
Equity
*Deduction from total SHE
- the residual interest in the assets of the
entity after deducting all its liabilities. Treasury stock / Treasury share
- total assets minus liabilities
Share capital
- Increased by profitable operations and
contribution by owners. - is the portion of the paid in capital
- Decreased by unprofitable operations representing the total par or stated
and distributions to owners. value of the shares issued.
*The term “equity” may simply be used for all Ordinary Share Capital
business entities.
Preference Share Capital
- Owner’s equity in a proprietorship
Subscribed share capital
- Partners’ equity in a partnership
- is the portion of the authorized share
- Shareholders’ equity in a corporation capital that has been subscribed but not
yet fully paid and therefore still
Shareholders’ Equity
unissued.
- residual interest of owners in the net
Subscriptions receivable
assets of a corporation measured by the
excess of assets over liabilities. - shall preferably be reflected as
deduction from the related subscribed
Philippines term / IAS
share capital. when collectible within
Share capital / Share capital one year shall be classified as current
asset. (Part of Trade and Other
*Under share capital
Receivables)
Subscribed capital stock / Subscribed share
Share premium
capital
- is the capital contributed by the
Preferred stock / Preference share capital
shareholders excess of the par or stated
Common stock / Ordinary share capital value of the shares subscribed and
issued.
*Under retained earnings
*Common Sources of share premium:
Retained earnings (deficit) / Accumulated
profits (losses) a. Excess of par or stated value (ch 20)

*Under Reserves b. Resale of Treasury Shares at more than cost

(ch 21)
Additional paid-in capital / Share premium
c. Donated Capital (ch 21)
d. Issuance of Share Warrants (ch 21) statement of financial position or in the
notes.
e. Distribution of Share Dividends (ch 22)
deposits on subscriptions
f. Quasi-reorganization and Recapitalization (ch
23) - to a proposed increase in share capital
may be reported as part of
shareholders’ equity as a separate item
Retained Earnings in the equity section. (nag-advance)

- represent the cumulative balance of Reserves

periodic net income or loss, dividend
- not officially defined in any accounting
distributions, prior period errors,
standard or in the conceptual
changes in accounting policy and other
framework.
capital adjustments including
- form a substantial part of the equity of
reclassification adjustments
an entity
(components of OCI subsequently
- Distributable equity is that portion that
reclassified to RE)
can be distributed to shareholders as
- Unappropriated retained earnings
dividends without impairing the legal
represent that portion which is free and
capital of the entity. (unappropriated
can be declared as dividends to the
retained earnings)
shareholders. (unrestricted)
- Non distributable equity is that portion
- Appropriated retained earnings
that cannot be distributed to the
represent that portion which is
shareholders in any form during the
restricted and therefore not available
lifetime of the entity. (reserves)
for any dividend declaration.
- deficit is a debit balance in retained *Example of Reserves
earnings. not presented as an asset but
Share premium reserve is the excess over the
as deduction from shareholders’ equity
par or stated value or popularly called
Treasury Shares additional paid in capital.

- an entity’s own shares that have been Appropriation reserve is the earmarking of
issued and then reacquired but not retained earnings for a certain purpose which
canceled. may be required by law, contract, or the result
- When treasury shares are acquired, the of a voluntary action of management.
retained earnings must be appropriated
Asset revaluation reserve arises from the
to the extent of the cost of the treasury
revaluation of property, plant, and equipment.
shares.
Specifically, this reserve is called revaluation
- The cost of treasury shares shall be
surplus.
shown as a deduction from the
shareholders’ equity. Other Comprehensive Income reserve
- The amount of reduction to equity for
treasury shares held shall be disclosed
separately either on the face of the
** Components of OCI Preference Share Capital

Subsequently reclassified to PROFIT/LOSS - So, called because of preferences

granted to the shareholders.
1. Unrealized gain or loss on debt
- Preferred as to dividends.
investment measured at fair value
- Preferred as to net assets in the event
through other comprehensive income.
of liquidation.
2. Gain or loss from translating the
- The preference shareholders have only
financial statements of a foreign
a limited or fixed return on investment
operation.
3. Unrealized gain or loss from derivative Legal Capital
contracts designated as cash flow
- Portion of the paid-in capital arising
hedge.
from the issuance of share capital which
Subsequently reclassified to RETAINED cannot be returned to the shareholders
EARNINGS in any form during the lifetime of the
corporation.
4. Unrealized gain or loss on equity
- In the case:
investment measured at fair value
Par Value shares- Aggregate par value
through other comprehensive income.
of all issued and subscribed shares
5. Revaluation surplus during the year
No-Par Shares- Total consideration
6. Remeasurement gain or loss of defined
received for the issuance of shares
benefit plan.
including the excess of issue price over
7. Change in the fair value attributable to
stated value.
credit risk of a financial liability
designated at fair value through profit
or loss. Trust fund doctrine

- Trust fund for the protection of the

Ordinary Share Capital
 If there is only one class of share capital,
it necessarily is ordinary share. called
because the ordinary shares have the
same rights and privileges.
creditors.
- It is illegal to return such legal capital to
shareholders during the lifetime of the
corporation
- Dividends to shareholders limited only
to the retained earnings balance

** Four Basic Rights of a Shareholder * TWO METHODS Accounting for share capital

- To share in the earnings of a corporation 1. Memorandum Method

(dividends)
- no entry is made to record the
- To vote in the election of directors and
authorized share capital. Only the
in the determination of certain
memorandum is made for the total
corporate policies
authorized share capital.
- To subscribe for additional share issues
- When share capital is issued, it is
right of pre-emption or share rights.
credited to the share capital account.
- To share in the net assets of the
corporation upon liquidation
2. Journal entry method
- The authorization to issue share capital
is recorded by debiting unissued share
capital and crediting authorized share
capital.
- When share capital is issued, it is
credited to the unissued share capital
account.
(Note: Difference lies in the entries pertaining
to authorization and issuance of share capital)
(The revised corporation code provides that
shares are issued only when subscriptions are
fully paid)
(A cash subscription is directly credited to the
share capital account. It is not necessary to set
up a subscription receivable account.)
Issuance of Share Capital
- When shares with par value are sold,
the proceeds shall be credited to the
extent of par value, with any excess
being reflected as share premium.
- When shares without par value are sold,
the proceeds shall be credited to the
extent of the stated value and any
excess is credited to share premium.
- The revised corporation code provides
that a share shall not be issued for a
consideration less than par or stated
value.
Investor’s (shareholders) Point of View
- Investment - buying or acquiring shares
(financial asset)
- Equity Security (financial asset) – any
instrument representing ownership of
shares and rights, warrants or options
to acquire or dispose of ownership
shares at a fixed or determinable price.
- Accounting Treatment – depends on
the purpose (accretion of wealth,
capital appreciation, ownership control
- Initial Measurement - FAIR VALUE
(transaction price / consideration given)
As a rule, transaction costs that are directly
attributable to the acquisition shall be
capitalized as cost of the financial asset.
If the financial asset is held for trading or if the
financial asset is measured at fair value through
profit or loss, transaction costs are expensed
outright.
(Note: The primary difference between
capitalizing and expensing costs is that you
record capitalized costs on a balance sheet,
and you record expensed costs on an income
statement or statement of cash flows.
Capitalized costs also display as investing cash
outflow, while expensed costs display as
operating cash outflow.)
PFRS 9 Financial Instruments - Under IFRS 9, a
financial asset is initially measured at fair value
plus transaction costs, unless it is carried at fair
value through profit or loss, in which case
transaction costs are immediately expensed.
MEASUREMENT (Accounting) OF EQUITY
INVESTMENTS (Financial Assets)
- Fair Value through Profit or Loss (FVPL)
- Held for trading, Not held for trading
(as a RULE), all other investments in
quoted equity instruments
- Fair Value through Other
Comprehensive Income (FVOCI) Not
held for trading – irrevocable election
- At COST Investment in unquoted equity
instruments
- EQUITY METHOD of accounting
Investments of 20% to 50% (associate -
significant influence)
 - CONSOLIDATION METHOD (advanced
accounting) Investments of more than
50% (subsidiary)
Shares Issued at a Discount
- When shares are sold at prices below
par or stated value
- Corporation Code prohibits the issue of
share at a discount
- When share is sold at a discount, the
discount is not considered a loss to the
issuing corporation, but the shareholder
is liable therefor.
- The issue of the share is not cancelled
but the shareholder must pay for the
discount. (Discount Liability of the
shareholder)
- Since a discount is an investment
deficiency, it should be accounted for
separately.
E.g.
If 10,000 shares of P100 par value are sold
for P800,00 cash
debit
CASH 800,000
DISCOUNT on SHARE CAPITAL 200,000
credit
SHARE CAPITAL 1,000,000
- Discount on Share Capital is a
deduction from total shareholders’
equity.
- The prohibition to issue shares at a
discount refers to original issue of share
but not to a subsequent transfer of such
share by the corporation.
- Treasury shares may be sold or reissued
for less than par value without violating
the provision of the law.
Issuance of Share Capital for Noncash
Considerations
 The Revised Corporation Code provides
that where the consideration for
issuance of share capital is other than
actual cash or consists of property such
as patent or copyright the valuation
thereof shall be initially determined by
the shareholders or the board of
directors subject to the approval of the
Securities and Exchange Commission.
 Reference is made to the fair value of
the property received.
 If share capital is issued for noncash
consideration such as tangible property,
intangible property and services, the
share capital is recorded at an amount
equal to the following order of priority:
1. Fair value of the noncash consideration
received.
2. Fair value of the shares issued.
3. Par value of the shares issued.
 PFRS 2, paragraph 10, provides that for
equity settled share-based payment
transactions, the entity shall measure
the goods and services received and the
corresponding increase in equity
directly at the fair value of the goods
and services received.
 If the entity cannot estimate reliably the
fair value of the goods and services
rendered, the entity shall measure their
value and the corresponding increase in
equity indirectly by reference to the fair
value of the equity instruments.
Equity Swap
 An equity swap is a transaction whereby
a debtor and creditor may renegotiate
the terms of a financial liability with the
result that the liability is fully or
partially extinguished by the debtor
 issuing equity instruments to the Organization Cost
creditor.
 represents cost incurred in forming or
 An equity swap is the issuance of share
organizing a corporation.
capital by the debtor to the creditor in
a. Legal fees in connection with the
full or partial payment of an obligation.
incorporation, such as drafting of
 “Extinguishment of a financial liability
articles of incorporation and by-laws
by issuing equity instruments.”
and corporate registration.
 IFRIC 19 provides that when equity
b. Incorporation registration.
instruments issued to extinguish all or
c. Share issuance cost, such as printing of
part of a financial liability are
stock certificates, cost of stock and
recognized initially, an entity shall
transfer book, seal of the corporation,
measure the equity instruments at the
underwriting and promotional fees, and
fair value of the equity instruments
accounting and legal fees in issuance.
issued, unless the fair value cannot be
 PAS 38, par 69, provides that “start-up
reliably measured.
costs which include legal and secretarial
 The equity instruments issued to
costs in establishing a legal entity shall
extinguish a financial liability shall be
be recognized as expense when
measured at the following amounts in
incurred.”
the order of priority:
 Accordingly, organization cost shall be
1. Fair value of the equity instruments
expensed immediately except for share
issued.
issuance costs.
2. Fair value of the liability extinguished.
3. Carrying amount of the liability Share Issuance Cost
extinguished
 The difference between the carrying  Are direct costs to sell share capital
amount of financial liability and the which normally include legal fees, CPA
initial measurement of the equity fees, underwriting fees, commissions,
instruments shall be recognized in profit cost of printing certificates,
or loss. documentary stamps, filing fees with
SEC and cost of advertising and
 The gain or loss on extinguishment shall
promotion or newspaper publication
be reported as a separate line item in
fee.
the income statement.
 PAS 32, par 37, provides that
Issuance of Share Capital for Services transaction costs that are directly
attributable to the issuance of new
 Shares may be issued for services as
shares shall be deducted from equity,
long as the services are already
net of any related income tax benefit.
rendered.
 In other words, share issuance cost shall
 In conformity with the legal provision
be debited to the share premium arising
and PFRS 2 (Share-Based Payment), if
from the share issuance.
shares are issued for services, the
 If the share premium is not sufficient to
shares shall be recorded at the (1) fair
absorb such costs, the excess shall be
value of such services or (2) fair value of
debited to “share issuance costs”
the shares issued, whichever is reliably
account to be presented as “contra
determinable.
 equity” or as a deduction from share
premium from previous share issuance
first and retained earnings second.
Cost of Public Offering
 The Philippine Interpretations
Committee (PIC) concluded that “costs
that relate to stock market listing”, or
otherwise are not incremental costs
directly attributable to the issuance of
new shares, shall be recorded as
expense in the income statement.
 The cost listing of shares are not
considered as costs of an equity
transaction since no equity instrument
has been issued. Such costs are
recognized immediately as expense
when incurred.
Cost of listing shares include the following:
1. Road show presentation
2. Public relations consultant’s fees
Joint Costs
 PAS 32, par 38, requires that transaction
costs that relate jointly to the
concurrent listing and issuance of new
shares, and listing of old existing shares
shall be allocated between the newly
issued and listed shares, and the newly
listed old existing shares.
 PAS 32 provides no further guidance as
to what basis of allocation should be
followed.
 The PIC concluded that the joint costs
shall be allocated prorate on the
outstanding newly issued and listed
shares and outstanding newly listed old
shares.
 (Pro rata is a Latin term used to describe a
proportionate allocation. It essentially
translates to "in proportion," which means
a process where whatever is being
allocated will be distributed in equal
portions.)
Examples of joint costs:
a. Audit and other professional advice
relating to prospectus
b. Opinion of Counsel
c. Tax opinion
d. Fairness opinion and valuation report
e. Prospectus design and printing
Watered Share
 Share capital issued for inadequate or
insufficient consideration.
 The consideration received is less than
par or stated value, but the share
capital is issued as fully paid.
 If the share capital is watered, asset is
overstated, and capital is
correspondingly overstated.
For example,
Land with fair value of P800,000 is received for
10,000 shares of P100 par value. The issuance of
shares is recorded as fully paid.
LAND 1,000,000
SHARE CAPITAL 1,000,000
It is illegal to issue share for less than par or
stated value. To correct the accounts:
DISCOUNT ON SHARE CAPITAL 200,000
LAND 200,000
(Land is overvalued and the share capital is
also overstated. In the example the
shareholder has a discount liability of 200k to
correct the account.)
Secret Reserve
 Reverse of watered share
 Arises when asset is understated, or
liability is overstated with a consequent
understatement of capital
  Usually arises from the following: Callable Preference Shares
a. Excessive provision for depreciation,
 One which can be called in for
depletion, amortization and doubtful
redemption at a specified price at the
accounts
option of the corporation.
b. Excessive writedown of receivables,
 No definite redemption date but
inventories and investments
dependent on the call of the issuer. An
c. Capital expenditures are recorded as
equity instrument rather than a
expense
financial liability because the option of
d. Fictitious liabilities are recorded.
the issuer to redeem the share for cash
Delinquent Subscription does not satisfy the definition of a
financial liability (PAS 32 Financial
 The Revised Corporation Code provides
Instruments)
that the board of directors may at any
time declare due and payable unpaid For example:
subscriptions.
An entity issued 10,000 callable preference
 This official declaration is called a CALL
shares of P100 par value at P120 per share.
usually expressed in the form of a board
resolution stating the date fixed for Cash 1,200,000
payment of unpaid subscriptions.
preference share capital 1,000,000
 If the shareholder does not pay on the
date fixed, the shareholder is declared share premium PS 200,000
delinquent, and the delinquent share
will be sold at a public auction. Subsequently the shares are called in at
 At the public auction, the delinquent P150 per share.
shares will be sold to the highest bidder. Preference share capital 1,000,000
The highest bidder is the person who is
willing to pay the offer price of the Share premium PS 200,000
delinquent shares for the smallest Retained earnings 300,000
number of shares.
 The offer price includes: Cash 1,500,000
a. Balance due on the subscription
 When preference shares are called in at
b. Interest accrued on the subscription
more than the original price of the
due
preference shares, the excess is debited
c. Expenses of advertising and other costs
to retained earnings.
of sale
 Accordingly, the excess of call price over
(if there is no bidders, the corporation may the par value of the preference shares
purchase for itself the delinquent shares. The is charge to the following:
delinquent subscriber is then released from a. Share Premium from original
liability then the subscription which is deemed issuance of preference share
fully paid.) b. Retained Earnings
Subsequently the shares are called in at P110
per share.

preference share capital 1,000,000

share premium - PS 200,000

cash 1,100,000

share premium – OS 100,000

 When preference shares are called in at

less than the original issue price, the
difference is simply credited to share
premium related to ordinary shares.

Redeemable Preference Shares

 PAS 32, par 18, defines redeemable

preference share as:
a. A preference share that provides for
mandatory redemption by the issuer for
a fixed or determinable amount at a
future date.
b. A preference share that gives the holder
the right to require the issuer to redeem
the instrument for a fixed or
determinable amount at a future date.
 A redeemable preference share shall be
reclassified as current or noncurrent
financial liability depending on the
redemption date.
 PAS 32, par 36, provides that the
difference between the redemption
price and the financial liability is
accounted for as gain or loss on
redemption.
 (Since it is a financial liability, the gain
or loss may arise. And the dividend
should be recorded as an interest
expense)
Convertible Preference Share
 A convertible preference share is one
which gives the holder the right to
exchange the holdings for other
securities of the issuing corporation.
 A preference shareholder may convert
the preference share into ordinary share
because operations are successful and
earnings on the ordinary shares are
unlimited.
 A preference shareholder may convert
the preference share into bonds which
is actually a change of equity from that
of an owner to that of a creditor.
Normally preference share is
convertible into ordinary share.
 A convertible preference share is an
equity instrument while a convertible
bond is a compound financial
instrument (IA2 CH7).
  To preserve the legal capital (trust fund
doctrine), the retained earnings must be
appropriated to the extent of the cost of
treasury shares and must not be
declared as dividend until the treasury
shares are subsequently reissued.

ACCOUNTING FOR TREASURY SHARES

COST METHOD

 Recorded at cost, regardless of whether

the shares are acquired below or above
CHAPTER 21
the par or stated value.
TREASURY SHARES, RIGHTS ISSUE, SHARE SPLIT  REASON: Legal limitation on acquisition
of treasury shares
 If the treasury shares are acquired for
TREASURY SHARES cash, the cost is equal to the cash
payment.
 Entity’s own shares that have been
 Cost if it is a cash (face value) then if it is
issued and then reacquired but not
a noncash assets (carrying amount)
cancelled.
 It is a contra equity so it is a deduction PAS 32, par 33, provides that no gain or loss
to SHE shall be recognized on the purchase, sale, issue
or cancellation of an entity’s equity instrument.
3 requisites to qualify as treasury shares:
 If the treasury shares are acquired for
A. The shares must be the entity’s own
noncash consideration, the cost is
shares.
usually measured by the carrying
B. The shares must have been issued
amount of the noncash asset
originally.
surrendered.
(Treasury shares can be legally reissued
 NOTE: The par value or stated value
at a discount without any discount
method is not an acceptable approach
liability while unissued shares must be
because of the legal requirement that
issued at least at par or at stated value.
“retained earnings must be
C. The shares are reacquired but not
appropriated to the extent of the cost of
cancelled.
treasury shares”.
LEGAL LIMITATION on TREASURY SHARES  (treasury shares are initially recorded
at cost of acquisition.
 The corporation can acquire treasury Subsequently, the treasury shares may
shares only to the extent of retained be reissued or sold at cost, more than
earnings balance. (The maximum cost or below cost.)
amount of acquiring treasury shares
would be the balance of retained
earnings- unappropriated or RE-
unrestricted.)
Reissuance of Treasury Shares @ COST
(Note: compare the reissue price vs. costs)
Reissuance at more than Cost
 not GAIN but credited to share premium
– treasury shares
Reissuance at below Cost
 not LOSS but debited to the order of
priority:
1. Share Premium – treasury shares of the
same class
2. Retained Earnings
RETIREMENT of TREASURY SHARES
a. The number of shares held in the
treasury.
b. The restriction on the availability of
retained earnings for distributions of
dividends equal to the cost of treasury
shares.
 PAS 32, par 33, provides that if an entity
reacquires its own equity instruments,
the treasury shares shall be deducted
from equity.
Under Application Guidance 36 of PAS 32, an
entity’s own equity instruments are not
recognized as financial asset regardless of the
reason for which the equity shares are
reacquired.

 If treasury shares are subsequently

retired, the share capital account is
debited at par value or stated value the
treasury shares account is credited at
cost.
 If the retirement resulted in a gain,
meaning the par value exceeds the cost
of treasury shares, such gain is credited
to share premium from treasury shares.
 If the retirement resulted in a loss,
meaning the cost of the treasury shares
exceed the par value, such loss is
debited in the order of priority:
1. Share Premium from original issuance
2. Share Premium from treasury shares
3. Retained Earning

(Note: the share premium from original

issuance is cancelled on a prorate basis in the
absence of specific amount identified with the
treasury shares.)

DISCLOSURE OF TREASURY SHARES

 The disclosure relating to treasury

shares shall include: