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FAR EASTERN UNIVERSITYSAMPALOC, MANILAConceptual Framework and Accounting Standards July 28, 2021Corporation Instructor: John Bo S. CayetanoLEARNING OBJECTIVES: Issuance of shares Subscription of shares Authorization of shares Reacquisition of shares Retirement of shares Donation from shareholders C...

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FAR EASTERN UNIVERSITY SAMPALOC, MANILA

Conceptual Framework and Accounting Standards Corporation

July 28, 2021 Instructor: John Bo S. Cayetano

LEARNING OBJECTIVES: 1. Issuance of shares 2. Subscription of shares 3. Authorization of shares 4. Reacquisition of shares 5. Retirement of shares 6. Donation from shareholders 7. Conversion of preference shares 8. Share split 9. Number of outstanding shares

REVIEW NOTES: The shareholders equity is divided into two major components: 1. Contributed Capital – This is the portion of shareholders’ equity coming from the investment made by the shareholders. The value of consideration invested by the shareholder is sub-divided into: a. Share Capital – the value invested equal to the par value of shares given-up. b. Share Premium – the excess of the value of consideration invested over the par value of shares givenup. Share premium is the “unrecognized gain” from transaction with shareholders, the gain earned from selling shares.

2. Earned Capital – This is the portion of shareholders’ equity coming from the cumulative earnings of the entity less any distribution of the earnings to the shareholders. Earned capital is divided into: a. Retained Earnings – Earnings recognized in the statement of profit or loss and available for distribution to shareholders. b. Other Comprehensive Income – Earnings recognized in the statement of other comprehensive income but not available for distribution to shareholders since the said income are not yet realized.

Shares Are document that proves the ownership of a person over a corporation. There are two types of shares, ordinary and preference shares. Area of comparison

Ordinary shares

Preference shares

As to distribution of income

Residual income

Fixed income

As to return of investment during liquidation of the company

Least priority

Priority

As to par value

Par value is not required

Par value is required

As to voting rights

With voting rights

Without voting rights

As to other feature

No other feature

-

Convertible Redeemable Attachable with warrants

Page 1 of 12

ISSUANCE OF SHARES: Shares are issued once sold to shareholders and the full consideration are received. On the first issuance of shares, it is not allowed to sold the shares below the par value. There are three (3) steps to account for this transaction: 1. Measure the value to the consideration received – Shares can be sold in exchange for the following: a. Cash – measured at face amount b. Noncash asset – measured using the following level of priority: 1st Fair value of noncash asset received 2nd Fair value of shares given up 3rd Part value of shares given up c. Service – measured using the following level of priority: 1st Fair value of service received 2nd Fair value of shares given up 3rd Par value of shares given up d. Extinguishment of debt – discussed in “Debt Restructuring” topic

2. Account for the gain – Gain arises if the consideration received is higher than the initial value (par value) of shares sold. It is not allowed to recognize gain from transaction to shareholders, thus, the gain is recognize as Share Premium instead of an income. If the share premium arose from original issuance, it is labelled “Excess over par”.

Less:

Consideration received Par value of shares issued Share premium – excess over par

P ( P

XX XX) XX

3. Account for the share issue cost – Share issue cost can be classified as: a. Direct share issue cost – Are accounted as a deduction to share premium from the transaction the share issue cost is incurred. If there are no share premium, it can either be expensed, deducted to retained earnings or treated as contra-equity account. This gray area are not commonly encountered in the problem. Direct share issue cost includes: - Documentary stamp tax - Other percentage tax - Underwriting cost - Newspaper publication - SEC registration fees b. Indirect share issue cost – Are expensed as incurred. This includes: - Public relations consultant’s fee - Road show presentation - Stock exchange listing fees

4. Lump Sum Issuance – The company may issue two class of shares (group of shares) for a consideration of one, it can also issue shares together with other instrument like bonds. The consideration received is allocated to the different instrument issued using the following allocation methods: a. Relative fair value method – all the fair value of shares (or securities) issued are available. Allocation:

Issue price of the Group

x

Total fair value of one class of shares Total fair value of the group

=

Amount allocated to one class of shares

b. Residual value method – fair value of one class of share is not available. The consideration received allocated to the shares with available fair value will its fair value, the residual of the consideration received will be allocated to the shares without fair value. Issue price of the whole group Fair value of the class of shares with available fair value Issue price allocated to the class of shares without fair value

P ( P

XX XX) XX

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c. Relative par value method – no fair value available for all the shares issued. Allocation:

Issue price of the Group

x

Total par value of one class of shares Total par value of the group

=

Amount allocated to one class of shares

SUBSCRIPTION OF SHARES: Corporation code do not allow issuance of share unless the full consideration is received. If an investor is intended to buy (invest) shares but do not have the capacity (money) yet to do so, the investor may “reserve” certain number of shares that the investor intended to buy. The said reserved shares are being subscribed. The company may ask for a down payment to ensure the purchase will push through.

a. Subscribed share capital – Par value of shares subscribed. Par value per share Times: Number of shares subscribed Subscribed share capital

P P

XX XX XX

b. Subscription receivable – The unpaid balance of the subscription price. If collectible beyond 12 months, subscription receivable is a contra-equity account. If collectible within 12 months, subscription receivable is a current asset. In absence of the collection period, it is classified as contra-equity.

Less:

Subscription price Down payment Subscription receivable

P ( P

XX XX) XX

c. Share premium, excess over par – Arises from the point subscription and no additional share premium on issuance.

Less:

Subscription price Par value of shares subscribed Subscription receivable

P ( P

XX XX) XX

d. Journal entry on subscription: Dr. Cash (Down payment) Dr. Subscription receivable Cr. Subscribed share capital Cr. Share premium – excess over par

XX XX XX XX

e. Journal entry on subsequent collection and issuance:

f.

Dr. Cash Cr. Subscription receivable

XX

Dr. Subscribed share capital Cr. Share capital

XX

XX

XX

Journal entry on cancellation of subscription: Dr. Subscribed share capital Dr. Share premium – excess over par Cr. Subscription receivable Cr. Share premium – excess over par

XX XX XX XX

AUTHORIZATION OF SHARES: The company may choose to account this transaction using the following method: a. Journal entry method – Under this method, a journal entry is required to set-up a principal account (Authorized share capital) and a contra-equity account (Unissued share capital) will be used. • Authorized share capital – is equal to the par value of shares authorized to be issued. This account will not change unless the number of authorized shares will change. • Unissued share capital – is equal to the par value of shares unissued. This account will decrease every time the company issue shares, in effect the carrying amount of equity will increase.

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Entry on authorization: Dr. Unissued share capital Cr. Authorized share capital

XX

Entry on issuance: Dr. Cash Cr. Unissued share capital

XX

XX

XX

b. Memo entry method – This method will not require a journal entry on authorization. No contra-equity account is set up. The account “share capital” will increase every time there is an issuance of shares. Entry on issuance: Dr. Cash Cr. Share capital

XX XX

REACQUISITION OF SHARES: Common reason for reacquisition: 1. Minimize the cost of capital (dividends) 2. Increase earnings per share 3. Prevent unfriendly take-over of the company Treasury shares (TS) Treasury shares are shares previously issued and subsequently reacquired. “Treasury shares” account is a contra-equity account and measured at cost. The cost of treasury shares will depend on the consideration given-up to reacquire the treasury shares: a. Cash – measured at face amount b. Noncash asset – measured at carrying amount of noncash asset c. Donated – zero

REISSUANCE OF SHARES: The term “reissue” pertains to treasury shares sold. There are two main issue in accounting for this transaction: a. Valuation of treasury sold – If a company reacquire a treasury shares with the same acquisition cost there is no accounting issue since all the cost of each treasury shares are the same. But if there are multiple acquisition during the year and the cost of each treasury shares are not the same, the problem will arise in determining the unit cost of treasury shares sold. For board exam purposes, cost flow method may be used by the company: • • •

Specific identification – The problem will state the unit cost of treasury shares sold FIFO – The unit cost of treasury shares first sold is the equal to the unit cost of the earliest purchased treasury shares. Average method – The unit of treasury shares sold is equal to the average unit cost computed by dividing the total peso amount of treasury shares available for sale by total number of units of treasury shares available for sale.

b. Gains and losses on reissuance – A gain will arise if the selling price exceeds the cost of treasury shares sold. While loss arises when the selling price is below the cost of treasury shares sold.

Less:

• •

Selling price Cost of treasury shares Gain (loss)

P ( P

XX XX) XX

Gain is recorded as “Share premium – treasury shares”. Loss is recorded as deduction to Share premium – treasury shares. If there is no Share premium – treasury shares or it can no longer absorb the loss, the excess will deducted to Retained earnings.

c. Journal entry on gain: Dr. Cash (selling price) Cr. Treasury shares (cost) Cr. Share premium – treasury shares

XX XX XX

d. Journal entry on loss: Dr. Cash (selling price) Dr. Share premium – treasury shares Dr. Retained earnings Cr. Treasury shares (cost)

XX XX XX XX

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RETIREMENT OF SHARES: Retirement of shares reacquires cancellation of the share certificate so it can no longer reissued. a. Advantage of retirement - When the company have treasury shares, appropriation of retained earnings is required. If the treasury shares were retired, TS will die and appropriation of retained earnings will no longer necessary b. Disadvantage of retirement - The company can avoid share issuance cost if the treasury shares were reissued rather than retired and issue from unissued shares.

Four (4) steps in accounting the retirement of shares: a. Derecognition of share capital account – share capital is derecognized equal to the par value of shares retired. b. Derecognition of share premium, excess allocated to the shares retired – the share premium, excess over par arise from the original issuance should be retired computed as follows: Total share premium, excess over par Divide: Number of shares issued Share premium, excess per share Times: Shares retired Share premium, excess of treasury shares retired

P P P

XX XX XX XX XX

c. Derecognize the treasury shares – equal to the cost of treasury shares retired. d. Gains or loss on retirement – A gain will arise if the original issue price of TS exceeds the cost of treasury shares retired. While loss arises when the original issue price is below the cost of treasury shares retired.

Add: Less:

• •

Par value of TS retired Share premium, excess of TS retired Original issue price Cost of treasury shares Gain (loss)

P P ( P

XX XX XX XX) XX

Gain is recorded as “Share premium – retirement”. Loss is recorded as deduction to Share premium – treasury shares. If there is no Share premium – treasury shares or it can no longer absorb the loss, the excess will deducted to Retained earnings.

e. Journal entry on gain: Dr. Share capital (Par) Dr. Share premium – excess over par Cr. Treasury shares (cost) Cr. Share premium – retirement f.

XX XX XX XX

Journal entry on loss: Dr. Share capital Dr. Share premium – excess over par Dr. Share premium – treasury shares Dr. Retained earnings Cr. Treasury shares (cost)

XX XX XX XX XX

CONVERSION OF PREFERENCE SHARE Convertible preference shares holds a privilege in which if exercised, the holder will send back the preference share to the company in exchange for ordinary shares.

Four (4) steps in accounting the retirement of shares: a. Record the retirement of Preference shares returned – This includes the derecognition of share capital and derecognition of share premium – excess over par. b. Record the issuance of Ordinary shares – The share capital – ordinary is recorded equal to the par value of ordinary shares issued in exchange of Preference shares returned.

Page 5 of 12

c. Gain or loss on conversion – A gain will arise if the original issue price of Preference shares returned exceeds the par value of Ordinary shares issued. While loss arises when the original issue price is below the par value of Ordinary shares issued. Add: Less: • •

Par value of Preference shares converted Share premium, excess of Preference shares converted Original issue price Par value of Ordinary shares issued Gain (loss)

P P ( P

XX XX XX XX) XX

Gain is recorded as “Share premium”. Loss is recorded as deduction to Retained earnings.

d. Journal entry on gain: Dr. Share capital – Preference Dr. Share premium, excess over par – Preference Cr. Share capital – Ordinary Cr. Share premium, excess over par – Ordinary

XX XX XX XX

e. Journal entry on loss: Dr. Share capital – Preference Dr. Share premium, excess over par Preference Dr. Retained earnings Cr. Treasury shares (cost)

XX XX XX XX

REDEEMABLE OF PREFERENCE SHARE This are Preference shares issued in which the issuing company has the right to reacquire the Preference share at a fixed price on a specific date. It is accounted in its substance rather than its form. The substance is the Preference share sold is only a collateral from a loan made by the entity and the price paid by the company to reacquire the share is really a loan repayment rather than a reacquisition. Thus, Redeemable preference share are recognize a long-term liability instead of equity and dividends distributed is recognize as interest expense. a. Entry on issuance: Dr. Cash Cr. Loans payable

XX XX

b. Entry on dividend distribution: Dr. Interest expense Cr. Cash

XX XX

c. Entry on reacquisition: Dr. Loans payable Cr. Cash

XX XX

DONATION: The consideration received from donation is measured at: 1. Cash – face amount 2. Noncash asset – fair value 3. Entity’s own share (treasury shares) – zero Corresponding credit: • Donation from shareholders – “Share premium – donated capital” since it is not allowed to recognize income • Donation from non-shareholder – “Other income” a. Entry on donation from shareholder of cash and noncash asset: Dr. Cash or noncash asset Cr. Share premium – donated capital

XX XX

b. Entry on donation from shareholder of treasury shares: No entry (memo entry only) c. Entry on subsequent reissuance of donated treasury shares: Dr. Cash Cr. Share premium – donated capital

XX XX

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