VIII – AUDIT OF EQUITY
PROBLEM NO. 1 - Equity components
The following data were compiled prior to preparing the statement of financial position of the
Conviction Corporation.
Authorized share capital, P100 par value P4,000,000
Unissued share capital
800,000
Subscribe share capital
480,000
Subscriptions receivable
120,000
Premium on share capital
320,000
Premium on bonds payable
240,000
Gain on sale of treasury shares
80,000
Donated capital
800,000
Share warrants outstanding
200,000
Reserve for bond sinking fund
400,000
Reserve for depreciation
600,000
Treasury shares, at cost
144,000
Retained earnings, unappropriated
720,000
Cash dividends payable
160,000
Revaluation increment on property
800,000
Net unrealized loss on available for sale
96,000
securities
Required:
Compute for the following:
1. Total share premium
2. Contributed capital
3. Appropriated retained earnings
4. Total Equity
5. Legal Capital
SOLUTION:
Requirement Nos. 1 to 4
Authorized share capital
4,000,000
Unissued share capital
(800,000)
Issued share capital
3,200,000
Subscribed share capital
480,000
Subscriptions receivable
(120,000)
360,000
Share premium
Premium on share capital
320,000
Gain on sale of treasury shares
80,000
Donated capital
800,000
Stock warrants outstanding
200,000
Contributed capital
1,400,000
4,960,000
(
1)
(
2)
Retained earnings
Appropriated for sinking fund
400,000
Appropriated for treasury shares
144,000
Total appropriated retained earnings
544,000
Unappropriated (P720,000 - P144,000)
576,000
(
3)
1,120,000
Revaluation surplus
800,000
Net unrealized loss on available for sale securities
(96,000)
Treasury shares
(144,000)
Total equity
6,640,000
(
4)
(5)
¸
Requirement No. 5
Issued share capital
3,200,000
Subscribed share capital
480,000
Legal capital
3,680,000
PROBLEM NO. 2 - Analysis of transactions affecting equity components
The shareholders’ equity accounts of Tenacity Corporation at December 31, 2014, had the
following balances:
Share capital - preference shares,
P100 par value, 6% cumulative;
15,000 shares authorized; 9,000
P900,000
shares issued and outstanding
Share capital - ordinary, P1 par value,
900,000 shares authorized;
600,000 shares issued and
outstanding
Share premium
Retained earnings
Total shareholder’s equity
600,000
1,200,000
3,300,000
P6,000,000
The following transactions occurred during 2015:

January 6 - Issued 22,500 ordinary shares to Weakness Company in exchange for land. On
the date issued, the share had a market price of P16.50 per share. The land had a carrying
amount of P210,000, and an assessed value for property taxes of P245,000.

January 31 - Sold 1,200, P1,000, 12% bonds, at 98 with one detachable share warrant
attached to each bond. Interest is payable annually on January 31. The fair value of the
bonds without the share warrants is 95. The detachable warrants have a fair value of P50
each and expire one year from issuance. Each warrant entitles the holder to purchase 10
ordinary shares at P10 per share.

February 22 - Purchased 7,500 of its own ordinary shares to be held as treasury shares for
P24 per share.

February 28 - Subscriptions for 21,000 ordinary shares were received at P26 per share,
payable 50% down and the balance by March 15.

March 15 - The balance due on 18,000 shares was received and those shares were issued.
The subscriber who defaulted on the 3,000 remaining shares forfeited the down payment in
accordance with the subscription agreement.

April 30 - Distributed property dividend to ordinary shareholders. The property had a
carrying amount of P910,000 and fair value of P950,000.

August 30 - Reissued 3,000 treasury shares for P20 per share.

September 14 - There were 945 warrants detached from the bonds and exercised.

November 30 - Declared a cash dividend of P2 per share to all ordinary shareholders of
record December 15, 2015. The dividend was paid on December30, 2015.

December 15 - Declared the required annual cash dividends on preference shares 2014. The
dividend was paid on January 15, 2015.

January 8, 2016 - Before closing the accounting records for 2015, Tenacity became aware
that no depreciation had been recorded for 2014 for a machine purchased on July 1, 2014.
The machine was properly capitalized at P480,000 and has an estimated useful life of eight
years when purchased. Tenacity is subject to 35% income tax. The appropriate correcting
entry was recorded on the same day.

Adjusted net income after tax for 2015 was P2,585,650.
Required:
Compute for the following as of December 31, 2015:
1. Share capital - preference shares
2. Share capital - ordinary shares
3. Share premium
4. Unappropriated retained earnings
5. Total equity
SOLUTION:
2012
Transaction
s
12.31.12
1/6
22,500
900,000
649,950
3/15
18,000
9/14
2/28
9,450
21,000
3/15
(18,000)
3/15
2/28
(3,000)
(273,000)
3/15
234,000
3/15
39,000
12.31.11
Share capital - PS
Share capital - OS
Subscribed share capital-OS
Subscriptions receivable
Share premium
900,000
600,000
-
-
1,200,00
0
1/6
348,750
-
-
2,158,80
0
Retained earnings - appropriated
Retained earnings - unappropriated
3,300,00
0
1/31
36,000
2/28
525,000
3/15
(75,000)
3/15
39,000
9/14
(28,350)
9/14
12/3
1
113,400
4/30
(950,000)
8/30
11/3
0
12/1
5
12/3
1
(12,000)
1/8
12/3
1
(19,500)
108,000
108,000
3,451,25
0
(1,290,900)
(54,000)
2,585,650
(108,000)
(108,000
Treasury shares
-
2/22
(180,000)
8/30
72,000
6,000,00
0
)
7,160,00
0
Journal entries for 2012
1/6
1/31
Land (22,500 shares x P16.50)
371,250
Share capital-OS (22,500 shares x P1)
22,500
Share premium-EOP
348,750
Cash (1,200 x P1,000 x .98)
Discount on bonds payable
P1,140,000)
Bonds payable
1,176,000
(P1,200,000
60,000
1,200,00
0
Share premium-warrants
2/22
36,000
Issue price with
Issue price without (1,200 x P1,000,000 x .
95)
1,176,000
Equity component
36,000
Treasury shares (7,500 x P24)
180,000
(1,140,000)
Cash
2/28
Cash (21,000 x P26 x 50%)
Subscriptions receivable (21,000 x P26 x
50%)
Subscribed share capital-OS (21,000 shares x
P1)
180,000
273,000
273,000
21,000
Share premium-EOP
3/15
Cash (18,000 x P26 x 50%)
525,000
234,000
Subscriptions receivable
Subscribed share capital-OS (18,000 shares x P1)
234,000
18,000
Share capital-OS
Subscribed share capital-OS (3,000 shares x
P1)
Share premium-EOP [3,000 shares x (P26 P1)]
4/30
18,000
3,000
75,000
Subscriptions receivable (3,000 x P26 x 50%)
39,000
Share premium - forfeited subscriptions
39,000
Retained earnings (at fair value)
950,000
Property dividends payable
8/30
950,000
Cash (3,000 x P20)
60,000
Retained earnings
Treasury shares (3,000 x
P24)
12,000
72,000
9/14
Cash (945 x 10 x P10)
Share premium-warrants
P36,000)
94,500
(945/1,200
x
28,350
Share capital-OS (945 x 10 x P1)
9,450
Share premium-EOP
113,400
11/3
0
Retained earnings
1,290,900
1,290,90
0
Dividends payable - OS
Ordinary shares issued and outstanding, 1/1
600,000
Shares issued, 1/6
22,500
Shares issued, 3/15
18,000
Shares issued, 9/14
9,450
Number of shares issued, 12/31
649,950
Treasury shares (7,500 - 3,000)
(4,500)
Number of shares issued and outstanding
645,450
Dividends per share
2.00
Total dividends
1,290,900
12/1 Retained earnings (900,000 x
5
6%)
54,000
Dividends payable - PS
1/8
54,000
Retained earnings
19,500
Income tax payable (480,000/8 x 1/2 x 35%)
10,500
Accumulated depreciation (480,000/8 x 1/2 )
12/3
1
P/L summary
30,000
2,585,650
2,585,65
0
Retained earnings
12/3 Retained
earnings
1
unappropriated
-
Retained earnings - appropriated (cost of TS)
108,000
108,000
PROBLEM NO. 3 - Audit of equity transactions and balances
With your representation, as Managing Partner of the Sy Pee Ey & Co., your firm was engaged
in the audit of the Fortitude Company at the close of the company’s first year of operations on
December 31, 2015. The company closed its books prior to the time you began your year-end
fieldwork.
Your audit and review showed the following shareholders’ equity accounts in the general ledger:
Share Capital
08/30
CD
P550,00
0
01/02
CR
12/29
J
P6,000,00
0
545,000
12/01
CR
P287,500
12/31
J
4,000,00
0
Retained Earnings
12/29
J
P545,00
0
Based on the other working papers submitted by your audit staff, the following additional
information was forwarded:
From the Articles of Incorporation Fortitude Company:


Authorized share capital - 150,000 shares
Par value per share - P100
From the board of directors’ minutes of meetings, the following resolutions were extracted:

01/02 - authorized the issuance of 50,000 shares at P120 per share.

08/30 - authorized the acquisition of 5,000 shares at P110 per share.

12/01 - authorized the re-issuance of 2,500 treasury shares at P115 per share.
12/29 - Declared a 10% share dividend, payable January 31, 2016 to shareholders on
record as of January 15, 2016. The market value of the share on December 29, 2015 was
P130 per share.
Required:

1. Prepare adjusting entries as of December 31, 2015.
2. Based on the above and the result of your audit, determine the adjusted balances of the
following as of December 31, 2015.
a. Share capital
b. Share premium
c. Total retained earnings
d. Total equity
SOLUTION:
Requirement no. 1
01/0
2
Share capital [50,000 shares (P120-P100)]
1,000,000
1,000,00
Share premium
08/3
0
Treasury shares
0
550,000
Share capital
12/0
1
12/2
9
Retained earnings
550,000
287,500
Treasury shares (2,500 shares x P110)
275,000
Share premium
12,500
Retained earnings (P617,500 - P545,000)
72,500
Share capital
545,000
Share dividends distributable (4,750 x P100)
475,000
Share premium
142,500
Shares issued
50,000
Treasury shares (5,000 -2, 500)
(2,500)
Shares outstanding
47,500
Dividend rate (small share dividend)
10%
Shares to be issued
4,750
Market value per share
130
12/3
1
Total amount to be charged to RE
617,500
Total par value of stock dividend payable
475,000
Share premium
142,500
Retained earnings (2,500 shares x P110)
275,000
Retained earnings appropriated for treasury shares
275,000
Requirement no. 2
5,000,00
Share capital (P5,995,000-P1,000,000+P550,000-P545,000)
0
Share dividends distributable
475,000
1,155,00
0
Share premium (P1,000,000+P12,500+P142,500)
Retained earnings-appropriated
275,000
3,382,50
Retained earnings (P3,742,500-P287,500-P72,500-P275,000)
3,107,500
Treasury shares (P550,000-P275,000)
0
(275,000)
9,737,50
0
Total equity
PROBLEM NO. 4 - Audit of retained earnings
The Retained Earnings account of Endurance Company shows the following debits and credits
for the year 2015:
RETAINED EARNINGS
Date
Jan.
1
(a)
(b)
(c)
(d)
Debit
Balance
Loss from fire
Write-off
of
goodwill
Share
dividends
distributed
Loss on sale of
equipment
Credit
Balance
Debit Credit
726,400
5,250
721,150
52,500
668,650
140,000
528,650
48,300
480,350
RETAINED EARNINGS
Date
(e)
(f)
(g)
(h)
(i)
(j)
Debit
325,500
Officers’
compensation
related
to
income
of
prior periods
accrual
overlooked
Loss
on
retirement of
preference
70,000
shares
at
more
than
issue price
Paid
in
capital
in
excess of par
Share
issuance
expenses
10,000
( related to
letter g)
Share
subscription
defaults
Gain
on
retirement of
preference
shares at less
than
issue
price
Credit
Balance
Debit Credit
154,850
84,850
129,500
214,350
204,350
8,470
212,820
25,900
238,720
RETAINED EARNINGS
Date
(k)
(l)
Debit
Gain
on
early
retirement
of bonds
Gain on life
insurance
Credit
Balance
Debit
Credit
15,050
253,770
10,500
264,720
(m)
(n)
(o)
(p)
(q)
policy
settlement
Correction
of
a
fundamental
error
Effect
of
change in
accounting
principle
from FIFO
to weighted
average
Dividends
25,000
Payable
Loss on sale
of treasury 20,000
shares
Proceeds
from sale of
donated
shares
50,050
314,320
100,000
414,320
389,320
369,320
40,000
409,320
RETAINED EARNINGS
Date
(r)
(s)
Debit
Credit
Balance
Debit
Credit
Appraisal
increase in
250,000
land
Gain on life
insurance
100,000
policy
settlement
659,320
559,320
Required:
1. Prepare adjusting journal entries to correct the Retained Earnings account.
2. Determine the correct amount of Retained Earnings account before closing the profit or
loss for the period.
SOLUTION:
a
Profit or loss (Other expense)
Retained earnings
5,250
5,250
b
Profit or loss (Other expense)
52,500
Retained earnings
d
Profit or loss (Other expense)
52,500
48,300
Retained earnings
g
Retained earnings
48,300
129,500
Share premium
h
Share premium
129,500
10,000
Retained earnings
i
Retained earnings
10,000
8,470
Share premium
j
Retained earnings
8,470
25,900
Share premium
k
Retained earnings
25,900
15,050
Profit or loss (Other income)
l
Retained earnings
15,050
10,500
Profit or loss (Other income)
q
Retained earnings
10,500
40,000
Share premium
r
Retained earnings
Revaluation surplus
40,000
250,000
250,000
Unadjusted retained earnings balance
559,320
a
5,250
b
52,500
d
48,300
g
(129,500)
h
10,000
i
(8,470)
j
(25,900)
k
(15,050)
l
(10,500)
q
(40,000)
r
(250,000)
Correct amount of RE before closing profit or loss
195,950
Alternative computation:
Jan.
1
Balance
726,400
c
Share dividend
(140,000)
e
Officers’ compensation related to income
of prior periods – accrual overlooked
f
(325,500)
Loss on retirement of preferred shares
at more than issue price
m
Correction of prior-period error
n
Effect of change in accounting principle
from FIFO to weighted average
(70,000)
50,050
100,000
o
Dividends payable
(25,000)
p
Loss on sale of treasury stock
(20,000)
s
Appropriated for property acquisition
(100,000)
Correct amount of RE before closing profit or loss
195,950
PROBLEM NO. 5 - Audit of equity transactions and balances
Resilience Corporation was organized on January 1, 2013, and began operations immediately.
Unfortunately, the company hired an incompetent bookkeeper. For the years 2013 through 2015,
the bookkeeper presented an annual balance sheet that reported only one amount for
shareholders’ equity: 2013, P1,377,000; 2014, P1,566,000 and 2015, P1,850,000. Also, the
condensed income statement reported as follows: 2013, net loss, Pl75,000; 2014, net profit,
P120,000; and 2015, net profit, P409,300 (cumulative earnings of P354,300). Based on the
P354,300, the president has recommended to the board of directors that a cash dividend f
P350,000 be declared and paid during January 2016. The outside director on the board has
objected on the basis that the company’s financial statements contain major errors (there has
never been an audit). You have been engaged to clarify the situation. The single shareholders’
equity account, provided by the bookkeeper, appeared as follows:
Shareholders’ Equity
2013
2013
2014
Share
issue costs
P13,000
Net loss
175,000
Bought
1,000
shares
from an
unhappy
7000
shareholde
r Ekis
2013
Ordinary
shares,
par
P
P1,600,000
5,200,00
0 shares
issued
2014
Net profit
(includin
g
P100,000
land
220,000
write-up
based on
president’
s
estimate)
Ordinary
shares,
2,000
18,000
shares
issued
Depreciation expense*
2014
(2013, P15,000;
2014, P17,000;
55,000
2015, P23,000)
Miscellaneous expense*
2015
Sold 300
of Ekis 2,700
shares
2015
Net
Profit
(2013, P20,000;
50,000
2014, P250,000;
2015, P5,000)
2015 Cash
100,000
loan to
409,300
the
company
president
P400,000
P2,250,000
* Recorded as expense but not shown on the income statement.
Required:
Based on the concerns of the outside director, answer the following:
1. What is the adjusted balance of retained earnings as of December 31, 2015?
2. What entry is necessary (a) to close the above single shareholders’ equity account and (b)
to record the various components of shareholders’ equity in separate accounts?
3. What is the adjusted total equity as of December 31, 2015?
SOLUTION:
Requirement no. 1
2010
2011
2012
RE
12.31.12
Unadjusted profit (loss)
(175,000)
220,000
409,300
454,300
Depreciation expense
(15,000)
(17,000)
(23,000)
(55,000)
Miscellaneous expense
(20,000)
(25,000)
(5,000)
(50,000)
Land write-up
Adjusted profit (loss)
(100,000)
(210,000)
78,000
Requirement no. 2
Shareholders equity
1,850,000
Treasury shares
4,900
Loans receivable
100,000
Share capital
1,010,000
Share premium – EOP
595,000
Share premium – TS
600
Land
100,000
Retained earnings
249,300
(100,000)
381,300
249,300
Requirement no. 3
Share capital
1,010,000
Share premium – EOP
595,000
Share premium – TS
600
Retained earnings
249,300
Treasury shares
(4,900)
Total equity
1,850,000
PROBLEM NO. 6 - Audit of equity-settled share-based payment
At the beginning of year 1, Entity A grants share options to each of its 100 employees working in
the sales department. The share options will vest at the end of year 3, provided that the
employees remain in the entity’s employ, and provided that the volume of sales of a particular
product increases by at least an average of 5 per cent per year. If the volume of sales of the
product increases by an average of between 10 per cent and 15 per cent each year, each employee
will receive 200 share options. If the volume of sales increases by an average of 15 per cent or
more, each employee will receive 300 share options.
On grant date, Entity A estimates that the share options have a fair value of P20 per option.
Entity A also estimates that the volume of sales of the product will increase by an average of
between 10 per cent and 15 per cent per year, and therefore expects that, for each employee who
remains in service until the end of year 3, 200 share options will vest. The entity also estimates,
on the basis of a weighted average probability, that 20 per cent of employees will leave before
the end of year3.
By the end of year 1, seven employees have left and the entity still expects that a total of 20
employees will leave by the end of year 3. Hence, the entity expects that 80 employees will
remain in service for the three-year period. Product sales have increased by 12 per cent and the
entity expects this rate of increase to continue over the next 2 years.
By the end of year 2, a further five employees have left, bringing the total to 12 to date. The
entity now expects only three more employees will leave during year 3, and therefore expects a
total of 15 employees will have left during the three-year period, and hence 85 employees are
expected to remain. Product sales have increased by 18 per cent, resulting in an average of 15 per
cent over the two years to date. The entity now expects that sales will average 15 per cent or
more over the three-year period, and hence expects each sales employee to receive 300 share
options at the end of year 3.
By the end of year 3, a further two employees have left. Hence, 14 employees have left during
the three-year period, and 86 employees remain. The entity’s sales have increased by an average
of 16 per cent over the three years. Therefore, each of the 86 employees received 300 share
options.
Required:
Compute for the amounts to be recognized as compensation expense in year 1 to 3.
SOLUTION:
Year
Computation
Comp. Exp.
Cumulative
1
80 × 200 options ×P20 × 1/3
106,667
106,667
2
(85 × 300 options ×P20 × 2/3) – P106,667
233,333
340,000
3
(86 × 300 options ×P20 × 3/3) – P233,333
176,000
516,000
PROBLEM NO. 7 - Audit of cash-settled share-based payment
An entity grants 100 cash share appreciation rights (SARs) to each of its 500 employees, on
condition that the employees remain in its employ for the next three years.
During year 1, 35 employees leave. The entity estimates that a further 60 will leave during years
2 and 3. During year 2, 40 employees leave and the entity estimates that a further 25 will leave
during year 3. During year 3, 22 employees leave. At the end of year 3, 150 employees exercise
their SARs, another 140 employees exercise their SARs at the end of year 5.
The entity estimates the fair value of the SARs at the end of each year in which a liability exists
as shown below. At the end of year 3, all SARs held by the remaining employees vest. The
intrinsic values of the SARs at the date of exercise (which equal the cash paid out) at the end of
years 3, 4 and 5 are also shown below.
Year
Fair value
Intrinsic value
1
P14.40
2
15.50
3
18.20
P15.00
4
21.40
20.00
5
25.00
Required:
Compute for the amounts to be recognized as compensation expense and liability in year 1 to 5.
SOLUTION:
Year Computation
Expense
Liability
1
405 × 100 SARs × P14.40 × 1/3
194,400
194,400
2
400 × 100 SARs × P15.50 × 2/3 - P194,400
218,933
413,333
3
253 × 100 SARs × P18.20 × 3/3 - P413,333
47,127
150 × 100 SARs × P15.00
225,000
113 × 100 SARs × P21.40 - P460,460
(218,640)
140 × 100 SARs × P20.00
280,000
0 - P241,820
(241,820)
113 × 100 SARs × P25.00
282,500
4
5
460,460
272,127
241,820
61,360
40,680
PROBLEM NO. 8 - Audit of cash or equity settled share-based payment
An entity grants to an employee the right to choose either 1,000 phantom shares, ie. a right to a
cash payment equal to the value of 1,000 shares, or 1,200 shares. The grant is conditional upon
the completion of three years’ service. If the employee chooses the share alternative, the shares
must be held for three years after vesting date.
At grant date, the entity’s share price is P50 per share. At the end of years 1, 2 and 3, the share
price is P52, P55 and P60 respectively. The entity does not expect to pay dividends in the next
three years. After taking into account the effects of the post-vesting transfer restrictions, the
entity estimates that the grant date fair value of the share alternative is P48 per share.
Required:
Compute for the amounts to be recognized as expense, equity and liability in year 1 to 3, if at the
end of year 3 the employee chooses:
1. The cash alternative
2. The equity alternative
SOLUTION:
The fair value of the equity alternative is P57,600 (1,200 shares × P48). The fair value of the cash
alternative is P50,000 (1,000 phantom shares × P50). Therefore, the fair value of the equity
component of the compound instrument is P7,600 (P57,600 – P50,000).
Year Computation
Expense
Equity
1
Equity component (P7,600 × 1/3)
Liability component (1,000 × P52 × 1/3)
2,533
17,333
2,533
Total
19,866
2,533
Equity component (P7,600 × 1/3)
Liability component [(1,000 × P55 × 2/3)-P17,333]
2,533
19,334
2,533
Total
21,867
5,066
Equity component (P7,600 - P5,066)
Liability component [(1,000 × P60 × 3/3)-P36,667]
2,534
23,333
2,534
Total
25,867
7,600
2
3
17,333
36,667
23,333
60,000
(60,000)
67,600
Scenario 2: 1,200 shares issued
Scenario 2 totals
17,333
19,334
Scenario 1: cash of P60,000 paid
Scenario 1 totals
Liability
67,600
7,600
-
60,000
(60,000)
67,600
-
PROBLEM NO. 9 - Book value per share
The equity section of the balance sheet of the Guts Company on December 31, 2015 shows the
following items:
6% Cumulative preference share capital,
P100 par value (liquidation value,
P115 per share); Authorized, 6,000 shares,
issued, 4,000 shares; in treasury, 600 shares P400,000
Ordinary share capital, P100 par value,
authorized, 20,000 shares; issued and
outstanding, 8,000 shares
800,000
Share premium - preference shares
150,000
Share premium - ordinary shares
165,000
Retained earnings
458,600
Reserve for bond retirement
320,000
Treasury shares - preference, at cost
(84,000)
Total
P2,209,600
Required:
1. Book value per share of ordinary
2. Book value per share of ordinary, assuming the preference share is participating
SOLUTION:
Requirement No. 1
Excess
Preferenc
over par
e
Balances
1,069,600
340,000
PS dividend (P340,000 x 6%)
PS liquidation premium (3,400 x
P15)
(20,400)
20,400
(51,000)
51,000
Balance to OS
998,200
Ordinary
*
800,000
Total
411,400
998,200
1,798,20
0
Divide by outstanding shares
3,400
8,000
Book value per share
121.00
224.78
Computation of "excess over
par"
Total equity
2,209,600
Outstanding par value of PS*
(340,000)
Outstanding par value of OS
(800,000)
1,069,600
Details of "excess over par"
Premium on PS
Premium on OS
150,000
165,000
Retained earnings,
retirement
appropiated
-
bond
320,000
Retained earnings, unappropiated
458,600
Excess of cost of TS over par (P84,000 P60,000)
(24,000)
Excess over par
1,069,600
Note: For computation of BV/share purposes, TS is treated as a retired
stock.
Shares
Amount
PS issued
4,000
400,000
Treasury PS, at par (600 x P100)
(600)
(60,000)
Outstanding PS
3,400
340,000
*
Requirement No. 2
Excess
Preferenc
over par
e
Ordinary
*
Balances
1,069,600
340,000
PS dividend (P340,000 x 6%)
PS liquidation premium (3,400 x
P15)
(20,400)
20,400
(51,000)
51,000
OS dividend (P800,000 x 6%)
(48,000)
Balance for participation
950,200
Preference (340/1,140 x P950,200)
800,000
48,000
283,393
Ordinary (800/1,140 x P950,200)
666,807
Total
694,793
1,514,80
7
Divide by outstanding shares
3,400
8,000
Book value per share
204.35
189.35
PROBLEM NO. 10 - Earnings per share
The information below pertains to Prancer Company for 2015.
Profit for the year
8% convertible bonds issued at par (P1,000
per bond). Each bond is convertible into
40 ordinary shares
6% convertible, cumulative preference shares,
P100 par value. Each share is convertible
into 3 ordinary shares.
Ordinary shares, P10 par value
Share options (granted in a prior year) to
purchase 50,000 ordinary shares at P20
per share
Tax rate
Average market price of ordinary shares
P1,200,000
2,000,000
3,000,000
6,000,000
500,000
40%
P25 per share
There were no changes during 2015 in the number of ordinary shares, preference shares, or
convertible bonds outstanding. There is no treasury share.
Required:
Compute basic and diluted earnings per share for 2015
SOLUTION:
Profit to OS
Basic
Exercise
options
1,020,000
of
Bond conversion
a
)
600,000
1.70
10,000
1,020,000
610,000
96,000
180,000
1,296,000
Notes:
EPS
-
c
)
1,116,000
PS conversion
WA Outs. OS
b
)
1.67
80,000
690,000
d
)
90,000
780,000
1.62
e
)
1.66
a
)
Profit for the year
1,200,000
PS dividend (P3M x .06)
(180,000)
1,020,000
b
)
Shares to be issued on exercise
Assumed TS acquired [(50,000 x
P20)/P25]
50,000
(40,000)
10,000
c Net interest
) conversion
savings
on
bond
(P2M x .08 x .6)
d
)
PS dividend (P3M x .06)
e
) Shares to issued on PS conversion
(P3M/P100 x
3)
96,000
180,000
90,000
PROBLEM NO. 11 - Earnings per share
Edmund Halvor of the controller’s office of East Aurora Corporation was given the assignment
of determining the basic and diluted earnings per share values for the year ending December 31,
2015.
Additional information:
a. The company is authorized to issue 8,000,000, P10 par value, ordinary shares. As of
December 31, 2014, 3,000,000 shares had been issued and were outstanding.
b. The per share market prices of the ordinary shares on selected dates were as follows.
Price per Share
July 1, 2014
P20.00
January 1, 2015
21.00
April 1, 2015
25.00
July 1, 2015
August 1, 2015
November 1, 2015
December 31, 2015
11.00
10.50
9.00
10.00
c. A total of 700,000 shares of an authorized 1,200,000 shares of convertible preferred
shares had been issued on July 1, 2014. The share was issued at its par value of P25, and
it has a cumulative dividend of P3 per share. The share is convertible into ordinary shares
at the rate of one share of convertible preference for one share of ordinary. The rate of
conversion is to be automatically adjusted for share splits and share dividends. Dividends
are paid quarterly on September 30, December 31, March 31, and June 30.
d. East Aurora Corporation is Subject to a 40% income tax rate.
e. The after-tax profit for the year ended December 31, 2015 was P13,550,000.
The following specific activities took place during 2015.
1. January 1 - A 5% ordinary share dividend was issued. The dividend had been declared on
December 1, 2014, to all shareholders of record on December 29, 2014.
2. April 1 - A total of 200,000 preference shares was converted into ordinary shares. The
company issued new ordinary shares and retired the preference shares.
3. July 1 - A 2-for-1 ordinary share split became effective on this date. The board of
directors had authorized the split on June 1.
4. August 1 - A total of 300,000 ordinary shares were issued to acquire a factory building.
5. November 1 - A total of 24,000 ordinary shares were purchased on the open market at P9
per share. These shares were to be held as treasury shares and were still in the treasury as
of December 31, 2015.
6. Ordinary shares cash dividends - Cash dividends to ordinary shareholders were declared
and paid as follows.
April 15 - P0.30 per share
October 15 - P0.20 per share
7. Preference shares cash dividends - Cash dividends to preference shareholders were
declared and paid as scheduled.
Required:
Compute Basic and diluted earnings per share for 2015.
SOLUTION:
Computation of basic EPS:
Profit for 2012
13,550,000
Less PS dividends:
March 31 (700,000 shares x P.75)
6/30, 9/30 & 12/31 (500,000 shares x P.75 x 3)
525,000
1,125,000
1,650,000
Profit to OS
11,900,000
/WA outstanding OS (see below)
6,736,000
Basic EPS
1.77
Computation of WA outstanding OS:
Date
Adj. shares
Mos. O/S
W.A
1/1/12
(3,000,000 x 1.05 x 2)
6,300,000
12/12
6,300,000
4/1/12
(200,000 x 1.05 x 2)
420,000
9/12
315,000
8/1/12
300,000
5/12
125,000
11/1/12
(24,000)
2/12
(4,000)
6,736,000
Computation of diluted EPS:
Profit to OS
11,900,000
Add PS dividends:
March 31 (700,000 shares x P.75)
6/30, 9/30 & 12/31 (500,000 shares x P.75 x 3)
525,000
1,125,000
1,650,000
Profit to OS
13,550,000
/WA outstanding OS (see below)
7,891,000
Diluted EPS
1.72
Computation of WA outstanding OS:
Number of shares to compute basic EPS
6,736,000
Convertible PS still outstanding (500,000 x 1.05 x 2)
1,050,000
Convertible PS converted (200,000 x 1.05 x 2 x 3/12)
105,000
Number of shares to compute diluted EPS
7,891,000
PROBLEM NO. 12 - Analysis equity transactions including EPS computation
Hawks Corporation was incorporated in 2014. During 2014, the company issued 100,000 shares
of P1 par value ordinary shares for P27 per share. During 2015, the company had the following
transactions.
1/2/15
Issued 10,000 shares of P100 par value cumulative
preference shares at par. The preference shares are
convertible into five ordinary shares and had a
dividend rate of 6%.
3/1/15
Issued 3,000 ordinary shares for legal service
performed. The value of the legal services was
P100,000. The shares are actively traded on a stock
exchange and valued on 3/1/12 at P32 per share.
7/1/15
10/1/15
Issued 40,000 ordinary shares for P42 per share.
Repurchased 16,000 treasury shares for P34 per
share
12/1/15
Sold 3,000 treasury shares for P29 per share.
12/30/15
Declared and paid a dividend of P0.20 per share on
ordinary shares and a 6% dividend on the
preference shares.
During 2014, Hawks Corporation had a profit of P250,000 and paid dividends of P28,000.
During 2015 Hawks Corporation had a profit of P380,000.
Required:
Based on the above and the result of your audit, determine the following:
1. Total share premium as of December 31,2015
2. Total retained earnings as of December 31, 2015
3. Total equity as of December 31, 2015
4. Basic earnings per share for the year 2015
5. Diluted earnings per share for the year 2015
SOLUTION:
Requirement No. 1-3
Share
premium
RE
Total equity
2011
Issued 100,000 ordinary shares at P27
2,600,000
2,700,000
Profit
250,000
250,000
Dividends
(28,000)
(28,000)
222,000
2,922,000
Balances, 12/31/11
2,600,000
2012
1/2/12 - Issued 10,000 PS at par
1,000,000
3/1/12 - Issued 3,000 OS for legal services
93,000
96,000
7/1/12 - Issued 40,000 OS at P42
1,640,000
1,680,000
10/1/12 - Repurchased 16,000 TS at P34
(544,000)
12/1/12 - Reissuance of 3,000 TS at P29
(15,000)
87,000
12/30/12 - PS dividend (P1M x .06)
(60,000)
(60,000)
(26,000)
(26,000)
380,000
380,000
4,333,000
501,000
5,535,000
(1)
(2)
(3)
'- OS dividend (130T x P.20)
Profit
Balances, 12/31/12
Requirement No. 4
Profit for 2012
380,000
Less PS dividend for 2012
60,000
Profit to OS
Divide by the WA outstanding OS (see
below)
320,000
Basic EPS for 2012
2.69
118,750
Computation of WA outstanding OS:
Shares
Time O/S
WA
1/1/12
100,000
12/12
100,000
3/1/12
3,000
10/12
2,500
7/1/12
40,000
6/12
20,000
10/1/12
(16,000)
3/12
(4,000)
12/1/12
3,000
1/12
250
118,750
Requirement No. 5
Profit to OS (see no. 4)
320,000
Add PS dividend for 2012
60,000
Adjusted profit to OS
380,000
Divide by the WA outstanding OS:
Actual (see no. 4)
118,750
Potential (10,000 x 5)
50,000
Diluted EPS for 2012
168,750
2.25
PROBLEM NO. 13 - Analysis equity transactions including EPS computation
The shareholders’ equity section of the Jerely Corporation’s statement of financial position as of
December 31, 2014 is presented below:
12% Preference share capital, P100 par
Ordinary share capital, P20 par
Share premium - preference
Share premium - ordinary
P 270,000
1,598,400
36,800
235,200
Share premium - treasury shares
Retained earnings
Total shareholders’ equity
3,200
1,585,840
P3,729,440
Jerely had 65,000 ordinary shares as December 31, 2013.
The following shareholders’ equity transactions were recorded in 2014 and 2015:
2014
May 1 - Sold 9,000 ordinary shares for P24, par value P20.
July 1 - Sold 700 preference shares for P124, par value P100.
Jul. 31 - Issued an 8% share dividend on ordinary shares. The market value of ordinary share was
P30 per share.
Aug. 30 - Declared cash dividends of 12% on preference shares and P3 per share on ordinary
shares.
Dec. 31 - Profit for the year amounted to P1,345,040
2015
Feb. 1 - Sold 2,200 ordinary shares for P30.
May 1 - Sold 600 preference shares for P128.
May 31 - Issued 2-for-1 split of ordinary shares. The par value of the ordinary share was reduced
to P10 per share.
Sep. 1 - Purchased 1,000 ordinary shares for P18 to be held as treasury shares.
Oct. 1 - Declared and paid cash dividends of 12% on preference shares and P4 per share on
ordinary shares.
Nov. 1 - Sold 1,000 shares of treasury shares for P22.
Dec. 31 - Profit for the year amounted to P991,520.
Required:
Determine the amounts, as required, in Jerely Corporation’s comparative financial statements as
of and for the years ended December 31,2014 and 2015.
1. Dividends paid to ordinary shareholders in 2015
2. Retained earnings as of December 31, 2015
3. Total equity as of December 31, 2015
4. Basic earnings per share for 2014
5. Basic earnings per share for 2015
SOLUTION:
Requirement No. 1
Ordinary shares outstanding, 12/31/11 (P1,598,400/P20)
79,920
Shares issued 2/1/12
2,200
82,120
Share split, 5/31/12
x
2
164,240
Treasury shares acquired, 9/1/12
(1,000)
Ordinary shares outstanding, 10/1/12
163,240
x Dividend per share
4
Dividends paid to ordinary shareholders
652,960
Requirement No. 2
Retained earnings, 12/31/11
1,585,840
Profit for 2012
991,520
Dividends - ordinary (see no. 36)
(652,960)
Dividends - preference [(P270,000 + P60,000) x .12]
(39,600)
Retained earnings, 12/31/12
1,884,800
Requirement No. 3
Total equity, 12/31/11
3,729,440
Add (deduct) 2012 transactions:
2/1 - Issuance of OS (2,200 x P30)
66,000
5/1 - Issuance of PS (600 x P128)
76,800
5/31 - share split
-
9/1 - Acquisition of TS (1,000 x P18)
(18,000)
10/1 - PS dividend (see no. 37)
(39,600)
- OS dividend (see no. 37)
(652,960)
11/1 - Re-issuance of TS (1,000 x P22)
22,000
Profit for 2012
991,520
Total equity, 12/31/12
4,175,200
Requirement No. 4
Profit for 2011
1,345,040
Less PS dividend (270,000 x 12%)
32,400
Profit to OS
1,312,640
Divide by weighted average number of OS (see below)
153,360
Basic earnings per share - 2011
8.56
Computation of weighted average number of OS
Adjusted
shares
Fraction
Total
Jan. 1 (65,000 x 1.08* x 2**)
140,400
12/12
140,400
May 1 (9,000 x 1.08* x 2**)
19,440
8/12
12,960
Total
153,360
*Share dividend, 7.31.11
**2-for-1 share split, 5.31.12
Requirement No. 5
Profit for 2012
991,520
Less PS dividend (P330,000 x 12%)
39,600
Profit to OS
951,920
Divide by weighted average number of OS (see below)
163,707
Basic earnings per share - 2012
5.81
Computation of weighted average number of OS
Adjusted
shares
Fraction
Total
Jan. 1 (79,920 x 2*)
159,840
12/12
159,840
Feb. 1 (2,200 x 2*)
4,400
11/12
4,033
Sept. 1
(1,000)
4/12
(333)
Nov. 1
1,000
2/12
167
Total
163,707
PROBLEM NO. 14 - Theory
Select the best answer for each of the following:
1. In an examination of shareholder’s equity, an auditor is most concerned that
a. Capital stock transactions are properly authorized.
b. Stock splits are capitalized at par or stated value on the dividend declarations date.
c. Dividends during the year under audit were approved by the shareholders.
d. Changes in the accounts are verified by a bank serving as a registrar and stock
transfer agent.
2. In audit of a medium-sized manufacturing concern, which one of the following areas can
be expected to require the least amount of audit time?
a. Owner’s equity
b. Assets
c. Revenue
d. Liabilities
3. When corporate client maintains its own stock records, the auditor primarily will rely
upon
a. Confirmation with the company secretary of shares outstanding at year-end.
b. Review of the corporate minutes for data as to shares outstanding.
c. Confirmation of the number of shares outstanding at year-end with the appropriate
state official.
d. Inspection of the stock book at year-end and accounting for all certificate numbers.
4. When a client company does not maintain its own share records, the auditor should
obtain written confirmation from the transfer agent and registrar concerning
a. Restrictions on the payment of dividends.
b. The number of shares issued and outstanding.
c. Guarantees of preferred stock liquidation value.
d. The number of shares subject to agreement to repurchase.
5. The auditor is concerned with establishing that dividends are paid to client corporation
shareholders owning shares of the
a. Issue date
b. Record date
c. Declaration date
d. Payment date
6. An audit program for the retained earnings account should include a step that requires
verification of the
a. Fair value used to charge retained earnings to account for a two-for-one share split.
b. Approval of the adjustment to the beginning balance as a result of a write-down of an
account receivable.
c. Authorization for both cash and share dividends.
d. Gain or loss resulting from disposition of treasury shares.
7. During an audit of an entity’s shareholders’ equity accounts, the auditor determines
whether there are restrictions on retained earnings resulting from loans, agreements, or
law. This audit procedure most likely is intended to verify management’s assertion of
a. Existence
b. Valuation
c. Completeness
d. Presentation and disclosure
8. If the auditee has a material amount of treasury shares on hand at year-end, the auditor
should
a. Count the certificates at the same time other securities are counted.
b. Count the certificates only if the company had treasury share transactions during the
year.
c. Not count the certificates if treasury share is a deduction from shareholders’ equity
d. Count the certificates only if the company classifies treasury shares with other assets.
9. In performing tests concerning the granting of stock options, an auditor should
a. Confirm the transaction with the Securities and Exchange Commission.
b. Verify the existence of option holders in the entity’s payroll records or stock ledgers.
c. Determine that sufficient treasury stock is available to cover any new stock issued.
d. Trace the authorization for the transaction to a vote of the board of directors.
10. The auditor would not expect the client to debit retained earnings for which of the
following transactions?
a. A 4-for-1 share split.
b. “Loss” resulting from disposition of treasury shares.
c. A 1-for-10 share dividend.
d. Correction of error affecting prior year’s earnings.
ANSWER:
1. A
2. A
3. D
5. B
6. C
7. D
4. B
8. A
9. D
10. A