Shareholders Equity ACTG 205 PDF

UNIT 6. SHAREHOLDERS’ EQUITY ACTG 205  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. A...

UNIT 6. SHAREHOLDERS’ EQUITY ACTG 205  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. A corporation is a legal or juridical person with a personality separate and apart from the individual members or shareholders. The corporation is not in fact and in reality a person but the law treats it as though it were a person by process of fiction.  ORGANIZATION OF A CORPORATION A corporation is created by operation of law. This means that a corporation cannot come into existence by mere agreement of parties as in the case of a business partnership. A corporation requires the authority and grant from the state. In the Philippines, the general law which governs the creation of private corporations is Republic Act 11232 otherwise known as Revised Corporation Code. Section 10 of the Revised Corporation Code provides that any person, partnership, association or corporation, simply or jointly with others but not more than fifteen in number may organize a corporation for any lawful purpose or purposes.  ORGANIZATION OF A CORPORATION Provided, that natural persons who are licensed to practice a profession and partnerships or associations organized for the purpose of practicing a profession shall not be allowed to organize as a corporation unless otherwise provided under special laws. A corporation with a single shareholder is considered a One Person Corporation. Section 3 provides that corporations formed or organized may be stock or nonstock corporations. Stock corporations are those which have capital stock divided into shares. All other corporations are nonstock corporations.  CONTENTS OF ARTICLES OF INCORPORATION All corporations shall file with the Securities and Exchange Commission the Articles of Incorporation containing substantially the following matters: a. The name of the corporation. b. The purpose or purposes for which the corporation is formed. c. The place where the principal office of the corporation is to be established or located which place must be within the Philippines.  CONTENTS OF ARTICLES OF INCORPORATION d. The term of existence if the corporation has not elected perpetual existence. e. The names, nationalities and residence addresses of the incorporators. f. The number of directors which shall not be more than fifteen or the number of trustees which may be more than fifteen. g. The names, nationalities and residence addresses of persons who shall act as directors until the first regular directors are duly elected.  CONTENTS OF ARTICLES OF INCORPORATION h. If it be a stock corporation, the amount of authorized capital stock, and the number of shares into which it is divided, the par value of each share, names, nationalities and residence addresses of original subscribers, amount subscribed and paid by each on the subscription. If the share has no par value, the Articles need state only the number of shares but the fact that the share is without par value shall be stated therein. i. If it be a nonstock corporation, the amount of its capital, the names, nationalities and residence addresses of the contributors and amount contributed by each. j. Such other matters consistent with law and which the incorporators may deem necessary and convenient.  CERTIFICATE OF INCORPORATION The corporation commences to have juridical personality and legal existence only from the moment the Securities and Exchange Commission issues to the incorporators a certificate of incorporation. Such certificate is a final determination of the corporation’s right to do business. The issuance of the certificate of incorporation calls the corporation to being but it is not yet ready to do business until it is organized Formal organization requires the adoption of bylaws which shall be filed with the Securities and Exchange Commission.  BYLAWS Bylaws may be defined as the rules of action adopted by the corporation for its internal government and for the government of its officers, shareholders or members. Among others, a private corporation may provide the following in its bylaws: a. The time, place and manner of calling and conducting regular or special meeting of directors, trustees, shareholders or members b. The number, qualifications, duties, responsibilities, length of office and compensation of directors or trustees c. The appointment, duties, responsibilities, length of office and compensation of corporate officers, other than directors or trustees. d. The manner of issuing stock certificates  MINIMUM CAPITAL STOCK “Section 12 of the Revised Corporation Code provides that stock corporation shall not be required to have a minimum capital stock, except as otherwise specifically provided by special law.”  COMPONENTS OF CORPORATION a. Corporators are those who compose the corporation whether shareholders or members or both. b. Incorporators are those corporators mentioned in the articles of incorporation as originally forming and composing the corporation. c. Shareholders or stockholders are owners of shares in a stock corporation. Under the Revised Corporation Code, shareholders and incorporators may be natural or artificial persons. d. Members are corporators of a nonstock corporation.  BOOKS AND RECORDS OF A CORPORATION a. Minutes book contains the minutes of the meetings of the directors and shareholders. b. Stock and transfer book is a record of the names of shareholders, installments paid and unpaid by shareholders and dates of payment, any transfer of share and dates thereof, by whom and to whom made. c. Books of accounts represent the record of all business transactions. The books of accounts include normally the journal and the ledger.  BOOKS AND RECORDS OF A CORPORATION d. Subscription book is a book of printed blank subscription. e. Shareholders' ledger is a subsidiary for the share capital issued reporting the number of shares issued to each shareholder f. Subscribers' ledger is a subsidiary for the subscriptions receivable account reporting the individual subscription of the subscribers. g. Share certificate book is a book of printed blank share certificates.  ORGANIZATION COST As the name suggests, the term organization cost represents cost incurred in forming or organizing a corporation. Specifically, the following should be included in organization cost: 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 share certificates, cost of stock and transfer book, seal of corporation, underwriting and promotional fees, accounting and legal fees related to share issuance.  ORGANIZATION COST PAS 38, paragraph 69, provides that start up costs which include legal and secretarial costs in establishing a legal entity shall be recognized as expense when incurred. Accordingly, it is now clearcut that organization cost shall be expensed immediately with the exception of share issuance costs which will be discussed later.  SHAREHOLDERS EQUITY Shareholders' equity or stockholders' equity is the residual interest of owners in the net assets of a corporation measured by the excess of assets over liabilities. Generally, the elements constituting shareholders' equity with their equivalent IFRS term are:  DEFINITION OF TERMS 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. The subscribed share capital is reported minus subscription receivable not collectible currently. Share premium is the portion of the paid in capital representing excess over the par or stated value.  DEFINITION OF TERMS Broadly, the common sources of share premium are: a. Excess over par value or stated value b. Resale of treasury shares at more than cost c. Donated capital d. Issuance of share warrants e. Distribution of share dividends f. Quasi-reorganization and recapitalization  DEFINITION OF TERMS 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. Deposits on subscriptions to a proposed increase in share capital may be reported as part of shareholders' equity as a separate line item in the shareholders' equity.  CAPITAL STOCK The term capital stock 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 operations. Actually, the amount fixed in the articles of incorporation is called the authorized share capital. The share capital is divided into shares evidenced by a share certificate.  CAPITAL STOCK A share represents the interest or right of a shareholder in the corporation. The four rights of a shareholder are: a. To share in the earnings of the corporation. b. To vote in the election of directors and in the determination of certain corporate policies. c. To subscribe for additional share issues - This is the right of preemption or share right. d. To share in the net assets of the corporation upon liquidation.  CAPITAL STOCK A share certificate is the instrument or document that evidences the ownership of a share. As a general rule, a share certificate is issued only when the subscription is fully paid. The share capital may be par value share or no-par value share. 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.  CAPITAL STOCK 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 Revised Corporation Code is P5. In other words, a no-par share cannot be issued for less than P5.  ORDINARY SHARE CAPITAL If there is only one class of share capital, it necessarily is ordinary share. Ordinary share is so called because the ordinary shareholders have the same rights and privileges. The ordinary shareholders enjoy no preference over each other. Generally, the ordinary share gives 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. The ordinary shareholders have no fixed or specific return on investment. Their financial reward is dependent on the operations of the entity If the entity is exceptionally profitable, the holdings of ordinary shareholders will become more valuable. Conversely, if an entity suffers losses, the value of the ordinary shareholders' equity will be reduced as fewer assets are available to satisfy residual claims.  PREFERENCE SHARE CAPITAL Preference share is so called because of the preferences granted to the shareholders. The preferences usually pertain to the preference shareholders’ claims on dividends and net assets in the event of liquidation. The preference shareholders have only a limited or fixed return on investment. For example, a holder of P100 par value, 12% preference share is entitled to an annual dividend, if declared, of 12% of P100 or P12.  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 a. In the case of par value share, legal capital is the aggregate par value of the shares issued and subscribed. b. In the case of no-par value share, legal capital is the total consideration received from shareholders including the excess over the stated value.  TRUST FUND DOCTRINE The trust fund doctrine holds that the share capital of a corporation is considered as trust fund for the protection creditors. Consequently, it is illegal to return such legal capital to shareholders during the lifetime of the corporation. However, the corporation can pay dividends to shareholders but limited only to the retained earnings balance. Accordingly, it is illegal to pay dividends if the entity has a deficit.  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. When share capital is issued, it is credited to the unissued share capital account. 6.1 ILLUSTRATION – MEMORANDUM METHOD 6.1 ILLUSTRATION – MEMORANDUM METHOD 6.2 ILLUSTRATION – JOURNAL ENTRY METHOD 6.2 ILLUSTRATION – JOURNAL ENTRY METHOD  ISSUANCE OF SHARE CAPITAL The Revised Corporation Code provides that a share shall not be issued for a consideration less than the par or stated value. The law further provides that shares without par value cannot be issued for less than P5. Thus, in the Philippines, the no-par share must have a stated value of at least 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.  ISSUANCE OF SHARE CAPITAL 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) 1,000,000 Share premium 500,000 Observe that the excess over the par value is credited to share premium.  ISSUANCE OF SHARE CAPITAL When shares without par value are sold, the proceeds shall be credited to the share capital account to the extent of the stated value and any excess is credited to share premium. 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  SHARES ISSUED AT DISCOUNT Shares sold or issued at a price below par or stated value are said to be issued at a discount. The Revised Corporation Code prohibits the issue of share at a discount. Thus, when a share is sold at a discount, the discount is not considered a loss to the issuing corporation but the shareholder is held liable therefor. Under Philippine jurisprudence, the issue itself is not void but the agreement that the share shall be paid for less than par value or stated value is illegal and cannot be enforced. The issue of the share therefore is not cancel but the shareholder must pay for the discount. This is called the discount liability of the shareholder. Since a discount is an investment deficiency, it should be accounted for separately..  SHARES ISSUED AT DISCOUNT For example, if 10,000 shares of P100 par value are sold for P800,000 cash, the journal entry is: Cash 800,000 Discount on share capital 200,000 Share capital 1,000,000 The account discount on share capital is a deduction from total shareholders' equity. It should be pointed out that the prohibition to issue share at a discount refers to the original issue of a share but not to a subsequent transfer of such share by the corporation. Hence, treasury shares may be sold or reissued for less than the par value or stated value without violating the provision of the law. Treasury shares will be discussed in a later chapter.  ISSUANCE OF SHARE CAPITAL FOR NONCASH CONSIDERATION The Revised Corporation Code provides that where the consideration for the 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. In other words, reference is made to the fair value of the property received, which must be determined by the shareholders or board of directors, subject to the approval of the Securities and Exchange Commission. The Revised Corporation Code further provides that shares shall not be issued in exchange for promissory notes or future service.  ISSUANCE OF SHARE CAPITAL FOR NONCASH CONSIDERATION 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. However, if the entity cannot estimate reliably the fair value of the goods and services received, the entity shall measure their value and the corresponding increase in equity indirectly by reference to the fair value of the equity instruments issued. Accordingly, 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 in the order of priority: a. Fair value of the noncash consideration received b. Fair value of the shares issued c. Par value of the shares issued 6.3 ILLUSTRATION  ISSUANCE OF SHARE CAPITAL SERVICES Shares may be issued for services as long as the services are already rendered. In conformity with the legal provision and accounting standard, if shares are issued for services, the shares shall be recorded at the fair value of such services or fair value of the shares issued, whichever is reliably determinable. Illustration: An entity issued 1,000 ordinary shares of P100 par value to lawyers for their legal services in getting the corporation organized.The fair value of such services is reliably determined to be P120,000. Legal expenses 120,000 Ordinary share capital 100,000 Share Premium 20,000  SHARE ISSUANCE COST Share issuance costs are direct costs to sell share capital which normally include legal fees, CPA fees, underwriting fees, commissions, cost of printing certificates, documentary stamps, filing fees with SEC and cost of advertising and promotion, or newspaper publication fee. PAS 32, paragraph 37, provides that transaction costs that are directly attributable to the issuance of new shares shall be deducted from equity, net of any related income tax benefit. In other words, share issuance costs shall be debited to share premium arising from the share issuance. If the share premium is insufficient to absorb such expenses, the Philippine Interpretations Committee or PIC concluded that the excess shall be debited to share issuance costs to be reported as a contra equity account as a deduction from the following in the order of priority: a. Share premium from previous share issuance b. Retained earnings  COST OF PUBLIC OFFERING OF SHARES The Philippine Interpretations Committee 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 costs of listing shares are not considered as costs of an equity transaction since no equity instrument has been issued. Therefore, such costs are recognized immediately as an expense when incurred. Costs of listing shares include the following: a. Road show presentation b. Public relations consultant's fees  JOINT COSTS PAS 32, paragraph 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. However, PAS 32 provides no further guidance as to what basis of allocation should be followed. The Philippine Interpretations Committee concluded that the joint costs shall be allocated pro rata on the basis of outstanding newly issued and listed shares and outstanding newly listed old existing shares. Examples of joint costs include the following: 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 Watered share is 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 value. To create a water in the share capital, the issuance of 10,000 shares is recorded as fully paid. Land 1,000,000 Share capital 1,000,000 Needless to say, the land is overvalued and the share capital is also overstated. As mentioned earlier, it is illegal to issue a share for less than the par or stated value. Thus in the example, the shareholder has a discount liability of P200,000. To correct the accounts, the journal entry is: Discount on share capital 200,000 Land 200,000  SECRET RESERVE The term secret reserve is the reverse of watered share. Secret reserve arises when asset is understated or liability is overstated with a consequent understatement of capital. Secret reserve usually arises from the following: a. Excessive provision for depreciation, depletion, amortization and doubtful accounts. b. Excessive write down of accounts receivable, inventory and investment. c. Capital expenditures are recorded as outright expense. d. Fictitious liabilities are recorded.  DELINQUENT SUBSCRIPTION The Revised Corporation Code provides that the board of directors may at any time declare due and payable unpaid subscriptions. This official declaration is called a call usually expressed in the form of a board resolution stating the date fixed for payment of the unpaid subscriptions. If the shareholder does not pay on the date fixed, the shareholder is declared delinquent and the delinquent share will be sold at public auction. At the public auction, so many delinquent shares as may be necessary to cover the unpaid subscription, interest accrued on the subscription, expenses of advertisement and other costs of sale will be sold to the highest bidder.  WHO IS THE HIGHEST BIDDER? The highest bidder is the person who is willing to pay the offer price of the delinquent shares for the smallest number of shares. The offer price normally includes the following: a. Balance due on the subscription b. Interest accrued on the subscription due c. Expenses of advertising and other costs of sale  WHO IS THE HIGHEST BIDDER? X subscribed for 10,000 shares at par P100, paying P600,000 as initial payment. The balance of the subscription was called and X failed to pay. Consequently, the subscription was declared delinquent. The offer price is P450,000 including the balance due on the subscription, interest and costs of sale. There are three bidders who are willing to pay the offer price, namely: A 4,500 shares B 5,000 shares C 6,000 shares Evidently, A is the highest bidder. Thus, all the 10,000 shares shall be deemed fully paid. Accordingly, A gets 4,500 shares, and X, the original subscriber, gets 5,500 shares.  NO BIDDER In case where there are no bidders, the corporation may purchase for itself the delinquent shares. The delinquent subscriber is then released from liability with regard to the subscription which is deemed fully paid. ILLUSTRATION  CALLABLE PREFERENCE SHARE A callable preference share is one which can be called in for redemption at a specified price at the option of the corporation. As distinguished from a redeemable preference share, a callable preference share has no definite redemption date as this is dependent on the "call" of the issuer. A callable preference share is an "equity instrument" rather than a financial liability because the option of the issuer to redeem the share for cash does not satisfy the "textbook" definition of a financial liability. ILLUSTRATION  CALLABLE PREFERENCE SHARE When preference shares are called in at more than the original issue price of the preference shares, the excess is debited to retained earnings. Accordingly, the excess of the call price over the par value of the preference shares is charged to the following: a. Share premium from original issuance of the preference shares b. Retained earnings On the other hand, when preference shares are called in at less than original issue price, the difference is simply credited to share premium related to ordinary shares  REDEEMABLE PREFERENCE SHARE PAS 32, paragraph 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 classified as current or noncurrent financial liability depending on the redemption date. REDEEMABLE PREFERENCE SHARE REDEEMABLE PREFERENCE SHARE  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 share 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. CONVERTIBLE PREFERENCE SHARE