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VIII. ACCOUNTING FOR CORPORATIONS Learning Objectives 1. State the components of shareholder’s equity. 2. Account for the initial issuances of shares of stocks. 3. Account for treasure shares.

Introduction As mentioned earlier, the accounting for assets and liabilities remains the same regardless of the form of a business organization (i.e., sole proprietorship, partnership, corporation or cooperative) – what changes is the accounting for equity. Corporation 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 a separate legal entity distinguished from its owners (i.e., shareholders or members). It is formed through an operation of law and not by mere agreement between the owners. It has the right of succession, meaning it continues to exist notwithstanding the withdrawal, death, insolvency or incapacity of the individual owners, and is dissolved only again through an operation of law. The operations of a corporation are subject to a higher degree of government regulation compared to other forms of businesses. Organization of a corporation Some of the provisions of the Corporation Code regarding the Organization of a corporation are highlighted below:  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 corporation’s authorized capital stock, which is the maximum number of shares that the corporation can issue. Any excess share issued is deemed illegal. In order to issue shares in excess of the originally authorized capital stock, the corporation must first 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 SEC’s approval.  At least 25% of the corporation’s authorized capitalization must be subscribed and at least 25% of the total subscription must be paid upon subscription. The paid-up capital cannot be less than five thousand pesos (₱5,000). Shareholder’s equity Shareholders’ equity is the residual interest in the assets of a corporation after deducting all its liabilities. This is the equivalent of the “Owner’s equity” in a sole proprietorship and the aggregate of partners’ capital balances in a partnership. The components of the shareholders’ equity include the following:  Share capital (Capital stock) Preference share capital (Preferred stock) Ordinary share capital (Common stock) Subscribed share capital (Subscribed capital stock)

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a. b. c. d. e.

Subscription receivable (as deduction) Share dividends distributable (Stock dividends payable) Capital liquidated (as a deduction) Share premium (Additional Paid-in capital) Other components of equity Treasury shares (Treasury stock)

The following transactions affect the accounting for a corporation’s equity: Authorization, subscription and issuance of shares Acquisition and reissuance of treasury shares Retirement of shares Donated Capital Distributions to owners (Dividends)

Accounting for share capital An entity accounts for its share capital using one of the following: 1. Memorandum method – Only a memorandum is made for the authorized capitalization. Subsequent issuances of shares are credited to the share capital account. 2. 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.” The difference between the “authorized share capital” and “unissued share capital” represents the issued share capital.  The more commonly used method in practice is the memorandum method. Illustration: Memorandum method vs. Journal entry method Authorized capitlatization 1. On January 1, 20x1, ABC Co. received authorization from the SEC to issue share capital of ₱1,000,000 divided into 10,000 shares with par value per share of ₱100. The authorized share capital is recorded under each of the two methods as follows: Memorandum method Journal entry method Memo entry – the authorized capitalization is Unissued share capital ₱1,000,000 Authorized share capital ₱1,000,000 ₱1,000,000 divided into 10,000 shares with par value per share of ₱100.  

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 no yet issued and is still available for subscription and issuance.

Subscription 2. Of the total share capital, 25% was subscribed at par value and 25% of the total subscription was paid at subscription date. Memorandum method Journal entry method Cash (1M x 25% x 25%) 62,500 Cash (1M x 25% x 25%) 62,500 Subscription receivable* 187,500 Subscription receivable* 187,500 Subscribed share capital 250,000 Subscribed share capital 250,000 (1M x 25%) (1M x 25%) *(250,000-62,500 = 187,500) Notice that same entry is made under both methods.

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Subscription - a contract between the purchaser of shares (i.e., investor) and the issuer (i.e., corporation) in which the purchaser promises to buy shares of the issuing company’s stocks at an agreed price. Subscription receivable – represents the unpaid portion of the subscription price. Subscription receivable is more commonly presented as a deduction from the related subscribed share capital, i.e., contra equity account. Subscribed share capital – represents the portion of the authorized share capital that is subscribed but not yet issued.

Collection of subscription receivable & Issuance of shares 3. On February 1, 20x1, ABC Co. received full payment for 2,000 subscribed shares and issued the related share certificates. Memorandum entry method Journal entry method Cash 150,000 Cash 150,000 Subscription receivable 150,000 Subscription receivable 150,000 Subscribed share capital 200,000 Subscribed share capital 200,000 Share capital 200,000 Unissued Share capital 200,000

Subscription price of 2,000 shares (2,000 x P100 par) Portion already paid (P200,000 x 25%) Balance collected  

200,000 (50,000) 150,000

Share capital – represents the portion of the authorized share capital that is already issued. Share certificate – is a document that evidences ownership of a share.

Notes:  “Share capital” is credited (under memorandum method) and “Unissued share capital” is credited (under journal entry method) only upon the issuance of shares.  Under the Corporation Code, shares (and share certificates) are issued to subscribers only upon full payment of the subscription price.  The Corporation Code prohibits the issuance of shares in exchange for promissory notes or future services. The corporation must receive first the full consideration before shares are issued.

Cash subscription 4. On February 28, 20x1, ABC received cash subscription for 1,000 shares at par value. Memorandum method Journal entry method Cash (1,000 x P100) 100,000 Cash (1,000 x P100) 100,000 Share capital 100,000 Unissued Share capital 100,000 

Notice that “Share capital” (‘Unissued share capital’) is directly credited (debited) for cash subscriptions.

 The share capital of ABC Co. as of February 28, 20x1 is shown below:

In the Philippines, “ subscription receivable” is more commonly presented as contra equity account (a deduction in equity), rather than as an asset as applied under traditional US GAAP.

Most companies use the memorandum method. As such, only this method will be used in the succeeding illustrations.

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Classes of share capital Share capital is basically classified into two, namely: a. Ordinary share capital (Common stock); and b. Preference share capital (Preferred stock). Ordinary shares Ordinary shares (common stock) represent the residual corporate interest that bears the ultimate risk of loss and receives the benefits of success. Ordinary shareholders are guaranteed neither dividends nor assets upon dissolution but they generally control the management of the corporation and tend to profit the most if the corporation is successful. If an entity has only one class of share capital, it necessarily is an ordinary share capital. The Corporation Code prohibits the issuance of only preference shares without ordinary shares. Ordinary shareholders, generally, enjoy the same rights with no preference over other shareholders. The following are the four basic rights of ordinary shareholders: 1. Right to attend and vote in shareholder’s 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 For stock corporations, voting rights are normally conferred to shareholders in proportion to their shareholdings. Thus, a shareholder who holds more shares normally will have more voting rights. The preemptive right (right of pre-emption) protects shareholders from involuntary dilution of their ownership interest. Without this right, an ownership interest may be reduced by the issuance of additional shares without the shareholder’s knowledge. Some corporations have more than one type of ordinary shares, such as “Class A” and “Class B” ordinary shares. In such cases, one class of ordinary shares (normally ‘Class A’, but not always) will have more voting rights than the other class. The class that has more voting rights is sometimes called “super voting” shares. One purpose of issuing “super voting” shares is to give key company insiders (e.g., founders and executives) greater control over the company’s voting rights. This enables them to control corporate policies and management decisions. Preference shares

Preference shares (preferred stocks) are shares that give the holders thereof certain preferences over other shareholders. Such preferences may include priority claims over (a) dividends and/or (b) net assets of the corporation in the event of liquidation. In exchange for such preference(s), preference shareholders sacrifice certain inherent rights of ordinary shareholders (e.g., voting rights over election of directors and officers). One purpose of issuing preference share is to broaden investor appeal, thereby increasing the corporation’s opportunity to generate equity financing. Share premium Share premium (additional paid-in capital) arises from various sources which include the following: a. Excess of subscription price over par value or state value. b. Excess of reissuance price over cost of treasure shares issued. c. Distribution of “small” stock dividends. Illustration: 1. ABC Co. started operations on January 1, 20x1. Its authorized capitalization is ₱1,000,000 divided into 10,000 shares with par value per share of ₱100. ABC Co. receives cash subscriptions for 5,000 shares at ₱120 per share.

2. On January 31, 20x1, ABC receives subscription for 2,000 shares at ₱160 per share.

Notes:  “Share capital” and “Subscribed share capital” are credited at par value regardless of the subscription price.  Share premium is credited at the subscription date even for subscriptions that are not yet paid; provided that, it is probable that the total subscription price will be collected.  ABC Co.’s total contributed capital as of January 31, 20x1 is computed as follows:

Par value and No-par value shares A par value share is one with a peso value fixed in the articles of incorporation. The purpose of which is to fix the amount of issuance price. A par value share cannot be issued below its par value. The par value appears on each share certificate issued. A non-par value share is one without a peso value fixed in the articles of incorporation. However, a no-par value share has a stated value (issue value) which is also indicated in the articles of incorporation but not on the share certificate issued. Par value and no-par value shares are distinguished by the presence or absence of a value per share on the share certificate issued. Under the Corporation Code, no-par value shares should not be issued for a

consideration less than five (₱5) peso per share. The excess of subscription price over the state value is credited to share premium. Example: An entity issues, 5,000 shares with stated value of ₱100 per share for P120 per share. The issuance is recorded as follows:

Under the Corporation Code, ordinary shares may be issued as either par or no-par value shares. However, preference shares should only be issued as par value shares. 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 based on the concept of trust fund doctrine which states that the share capital of a corporation is a trust fund held for the protection of its creditors. Legal capital is computed as follows: a. For par value shares, legal capital is the aggregate par value of shares issued and subscribed. b. 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. Illustration: Legal Capital The equity section of ABC Co’ statement of financial position shows the following information:

Requirements: Compute for the legal capital assuming: a. The ordinary shares are par value shares; and b. The ordinary shares are no-par value shares. Solutions:

Notes:  In case of no-par value shares, legal capital includes the share premium of ordinary shares.

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Preference shares can only be issued as par value shares. Thus, the share premium of the preference shares is not included.

Share issuance costs Issuing share entails expenditures, 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. These expenditures, called ‘share issuance costs’, are deducted from any resulting share premium from the issuance. If share premium is insufficient, the excess is charged to retained earnings. Illustration On January 1, 20x1, ABC Co. issued 1,000 shares with par value of P100 for P120 per share. Share issuance costs amounted to P5,000. The entries are as follows:

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 Treasury shares are accounted for using the cost method. Under this method, the reacquisition and subsequent reissuance of treasury shares are recorded at cost. Treasury shares are presented as deduction in the shareholders’ equity (i.e., contra equity account). Illustration: On January 1, 20x1, the statement of financial position of ABC Co. shows the following information:

 On July 1, 20x1, ABC reacquires 1,000 shares at P90.

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Retained earnings represent the cumulative profits (net of losses, distribution to owners, and other adjustments) that are retained in the business and not yet distributed to the shareholders. Total retained earnings may consist of: a. Unrestricted – the portion of retained earnings that is available for future distribution to the shareholders. b. Appropriated (Restricted) – the portion of retained earnings that is not available for distribution unless the restriction is subsequently reversed.

Case 1: Reissuance at cost On September 1, 20x1, ABC reissues the 1,000 treasury shares at P90.

When treasury shares are reissued, the related reverted back to unrestricted retained earnings.

appropriated retained earnings

are

Case 2 – Reissuance at more than cost On September 1, 20x1, ABC reissues the 1,000 treasury shares at P140.

When treasury shares are reissued at more than the reacquisition cost, the excess of the reissuance price over the cost is credited to “Share premium – treasury shares.” This forms part of the entity’s total share premium. Case 3- Reissuance at below cost On September 1, 20x1, ABC reissues the 1,000 treasury shares at P60.

When treasury shares are subsequently reissued at below the reacquisition cost, the excess of the cost over the reissuance price is debited to the following in the order of priority: a. Any balance in “share premium – treasury shares” arising from the same class of share capital. b. If the balance in “share premium – treasury shares” is insufficient or if it has no outstanding balance, any excess is debited to retained earnings. In the illustration above, since ABC Co. does not have “Share premium – treasury shares”, the 30,000 excess (i.e., P90,000 reacquisition cost – P60,000 reissuance price) is debited to “Retained earnings.” Retirement of shares Shares are considered retired if they have been reacquired and cancelled in accordance with the Securities and Exchange Commission (SEC) regulations. Unlike for treasury shares which can be subsequently reissued, retired shares cannot be reissued anymore. When shares are retired, the total par value and the related share premium of the retired shares are removed from the books of accounts. Any difference between the total amount removed and the retirement cost is accounted for as follows: 1. If the par value and related share premium of the retired shares exceed the retirement cost, the difference is credited to “Share premium – retirement.” 2. If the par value and related share premium of the retired shares are less than the retirement cost, the difference is debited to the following order of priority: a. Share premium – treasury shares b. Retained earnings Illustration: Retirement of shares On January 1, 20x1, the statement of financial position of ABC Co. shows the following information:

Case 1 – Retirement cost less than Original issuance price ABC reacquires 1,000 shares at P80 per share on July 1, 201x and retires them on September 1, 20x1. July 1 – Reacquisition

Sept. 1 – Retirement

To simplify the illustration, journal entries for the appropriation of retained earnings and the reversal thereof are ignored.

*The share premium from original issuance is computed as follows:

Case 2 – Retirement cost greater than Original issuance price  ABC reacquires 1,000 shares at P140 on July 1, 20x1 and immediately retires them.

When shares are reacquired and immediately retired, there is no need to set up a treasury share account. The par value and related share premium of the retired shares are immediately debited, with a corresponding credit to “Cash”. Notice that in the accounting for treasury shares and retirement of shares, retained earnings may be decreased but never increased. Donated capital Donated capital arises from gifts received by the corporation from nonreciprocal transactions. Donated capital may arise from the following: 1. Donations from shareholders – these are credited to share premium. 2. Donations from the government – these are recognized as government grants. 3. Donations fro...