AUD 323

Auditing & Assurance: Concepts &

Applications

Reference: Intermediate Accounting I volume 2 2020 by Conrado Valix, , Jose Peralta &
Christian Aris M. Valix
 Retained Earnings

Share-based Compensation

Reference: Intermediate Accounting I volume 1 2020 by Conrado Valix, , Jose Peralta &
Christian Aris M. Valix
Retained Earnings
Retained Earnings
represent the cumulative balance of the following:

• Net Income or loss for the period

• Dividend Distribution

• Prior Period Errors

• Changes in Accounting Policy

• Reclassifications of some components of OCI

• Other Capital Adjustments

Kinds Retained Earnings
Dividends
are distributions of earnings or capital to the shareholders in proportion to their shareholdings.

Classification of Dividends
a. Dividends out of earnings

b. Dividends out of Capital

When dividends are formally declared by the board of directors, three dates are essential for accounting
purposes:
a. Date of declaration – recognition date
b. Date of record
c. Date of payment
Dividends out earnings

a. Cash dividends

b. Property dividends

c. Liability dividends (bond and scrip)

Scrip is like a note which is a formal evidence of indebtedness to pay sum of money at some future time.

d. Share dividends or bonus issue

Property dividends (dividends in kind)
Accounting for property dividend is now covered by IFRIC 17. Property dividends are considered as
“distribution of non-cash assets to owners”.

Two Accounting issues:

1. Measurement of Property Dividend Payable

at fair value of the asset to be distributed on the date of declaration and is increased or decreased as result of
change in fair value of the asset at year-end and date of settlement. At the date of settlement, difference of CA
of dividend payable and CA of asset distributed shall be recognized in profit or loss.

2. Measurement of the noncash asset to be distributed as property dividend

at lower of Carrying amount and fair value less cost to distribute
Share Dividend or Stock Dividend (bonus issue)
Distribution of the earnings of the entity in the form of the entity’s own shares.

• Retained earnings are capitalized, meaning transferred to share capital

• Assets of the entity remain the same before and after the issuance of the share dividends

• Decrease retained earnings but increase share capital.

Share Dividend or Stock Dividend (bonus issue)
How much of the retained earnings should be capitalized?

Small Share Dividends

Large Share Dividends

Dividends out of Capital
When capital is returned to shareholders, it is known as dividend out of capital or liquidating dividend.

Trust Fund Doctrine – illegal to return capital to shareholders (Retained Earnings balance can only be
distributed to shareholders)

Wasting Asset Doctrine – dividends can declared to the extent of RE balance plus accumulated depletion
balance.
Statement of Retained Earnings
Items affecting directly retained earnings:
RETAINED EARNINGS

xx Beginning Balance
Prior period errors xx xx Prior Period errors
Change in Acctg Policy xx xx Change in Acctg Policy
xx Corrected Beg. Balance
Net Loss xx xx Net Income
Dividends Declared xx xx OCI components reclassified
Appropriation of RE xx
OCI components reclassified xx
Retirement of Treasury shares xx
Recognition of SIC xx
Call of preference shares xx
Conversion of PS to OS xx
xx ending balance
Reserves
Under International Accounting Standards, the use of equity reserves is based on whether a reserve is part of
distributable equity or nondistributable equity.

Distributable Equity – pertains to unappropriated retained earnings

Non-distributable equity reserves – represent those items of equity other than the aggregate par o stated value of
share capital and retained earnings unappropriated.

• Share premium reserves – Share premium

• Appropriation reserves – appropriated RE
• Asset revaluation reserve – revaluation surplus
• OCI reserve
Statement of changes in equity

Share Capital Reserves Retained Earnings

Beg.Bal

Ending bal.
Quasi-Reorganization (Corporate readjustment)
Is a permissive but not mandatory procedure under which a financially troubled entity restates its accounts and
establishes a “fresh start” in accounting sense and for the purpose of eliminating deficit. This must be
approved by SEC.

This can be accomplished thru:

a. Recapitalization – total resulting deficit is charge to SHARE PREMIUM

b. Revaluation of PPE - total resulting deficit is charge to REVALUATION SURPLUS

Shared-Based Compensation
Share-based Compensation
Is a compensation arrangement established by the entity whereby the entity’s employee shall receive shares of
capital in exchange for their services or the entity incurs liabilities to the employees in amounts based on the
price of its shares.

This is common feature of employee remuneration for directors, senior executives and other key employees.

PFRS 2 sets out the measurement principles and specific requirements for accounting of the following share-
based compensation:

a. Equity Settled – share options

b. Cash Settled – share appreciation rights

Share-based Compensation – Equity Settled = Share Options

Measurement of Compensation
a. Fair Value Method
Compensation = Fair Value of Share Options on the date of grant.

b. Intrinsic Value Method

Compensation = Intrinsic value of share options

Intrinsic Value = Market Value of Share –Option Price

PFRS 2, p 24, provides that intrinsic value method can only be used only if the FAIR VALUE of share option
cannot be estimated reliably. The entity shall measure the share options at their intrinsic value initially and
subsequently at each reporting date and at a date of final settlement, with any change in intrinsic value
recognized in P/L/
Share-based Compensation – Equity Settled = Share Options

Recognition of Compensation Expense

a. If share options vest immediately, the employee is not required to complete a specified period of service
before unconditionally entitled to the share options. In this case, ON GRANT DATE, the entity shall recognize
compensation as expense in FULL with corresponding increase in equity.

Share Options x Fair Value/Intrinsic Value = Compensation Expense

Salaries - SO xx
Share Options Outstanding (SOO) xx

Cash xx
SOO xx
SC xx
SP xx
Share-based Compensation – Equity Settled = Share Options
b. If share options do not vest until the employee completes a specified service period, the compensation
recognized as expense over the service period or vesting period, meaning from the date of grant to the date on
which options can first be exercised.

Share Options x Fair Value/Intrinsic Value = Total Compensation / service/vesting period

Year 1
Salaries - SO xx
Share Options Outstanding (SOO) xx

SOO – is reported as component of share premium. If these are not subsequently exercised it shall be adjusted
and closed to share premium.
Share-based Compensation – Equity Settled = Share Options
Intrinsic Value Method
Compensation = Intrinsic value of share options

Intrinsic Value = Market Value of Share –Option Price

PFRS 2, p 24, provides that intrinsic value method can only be used only if the FAIR VALUE of share option
cannot be estimated reliably. The entity shall measure the share options at their intrinsic value initially and
subsequently at each reporting date and at a date of final settlement, with any change in intrinsic value
recognized in P/L/

Note: Increase in INTRINSIC VALUE after the vesting period is recognized as additional compensation
immediately.
Share-based Compensation – Equity Settled = Share Options
Acceleration of Vesting
If the entity cancels or settles a grant of share options during the vesting period, the entity shall account for
the cancellation or settlement as an acceleration of vesting.

a. The entity shall recognize immediately the compensation expense that otherwise would have recognized
for services rendered over the remainder of the vesting period.

b. Any payment made to employee on the cancelation or settlement of the grant shall be accounted for as the
repurchase of equity interest, deduction from equity. If payment exceeds the fair value of the share option the
excess shall be recognized as an expense.
Share-based Compensation – Cash Settled = Share Appreciation Rights
Cash Settled Transactions
is a share based payment transaction whereby entity incurs a liability for services received and the liability is
based on the entity’s equity instruments.
the entity shall measured the services acquired and the liability incurred at the FAIR VALUE of the liability.

FAIR VALUE. = Market Value of Share – Predetermined Price

until the liability is settled, the entity shall remeasure the fair value of the liability at each reporting date and
at a date of settlement with any changes in fair value recognized in profit or loss.

Share Appreciation Rights

Entitles an employee to receive cash which is equal to the excess of the market value of the entity’s share
over a predetermined price for a stated number of shares.
Share-based Compensation – Cash Settled = Share Appreciation Rights
Recognition of Compensation

a. If the share appreciation right vest immediately, the compensation is recognized immediately on the date
of the grant.

b. If the SAR does not vest until the employee completes a definite vesting period, the compensation is
recognized over the service or vesting period.

# of shares x (Market Price – Predetermined Price) = Total Compensation / vesting period

Salaries xx
Accrued Salaries Payable xx
Modification from Cash-settled to equity settled
Following procedures shall be applied based on PFRS 2, par. B44A as amended:

1. The equity-settled share based payment transaction is measured based on the fair value of such equity
instruments granted on the modification date and is recognized in equity.

2. The liability for cash settled share based payment transaction as of modification date is derecognized

3. The difference between the CA of liability and the amount of equity is recognized immediately in P/L.
Cash and Share Alternative
Accounting for this type of instrument depends on which party has the choice of settlement.