SHAREHOLDERS’ EQUITY
INTRODUCTION
The three forms of business organization
proprietorship, partnership and corporation.
are
single
➢ In a single proprietorship, the owner's claim against the assets
is called capital or owner's equity.
➢ In a partnership, the partners' claim against the assets is called
partners' capital or partners' equity.
➢ In a corporation, the owners claim against the assets is called
shareholders' equity or stockholders' equity.
However, the term "equity" may simply be used for all the business
organizations.
Actually, accounting records for these business organizations are
practically the same except the accounting for the capital accounts.
In a single proprietorship and partnership, the investment of the
owner or owners and the changes therein resulting from net income
or loss from operations are recorded in the capital accounts.
In a corporation, distinction is made between invested capital and
earnings or losses accumulated in the business.
This distinction and other matters affecting the shareholders equity
will be discussed in this chapter.
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 who, as
natural persons, are merged in one corporate body.
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.
The shareholders or members compose the corporation but they are
not the corporation.
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 the Corporation Code.
Private corporations owned or controlled by the government or any
subdivision or instrumentality thereof are created by special laws.
LEGAL REQUIREMENT
The Corporation Code provides that five or more persons, not
exceeding fifteen, a majority of whom are residents of the
Philippines, may form a private corporation for any lawful
purpose or purposes by filing with the Securities and Exchange
Commission the articles of incorporation, duly executed and
acknowledged before a notary public.
CONTENTS OF ARTICLES OF INCORPORATION
a)
b)
c)
d)
e)
f)
g)
h)
The name of the corporation.
The purpose or purposes for which the corporation is formed.
The place where the principal office of the corporation is to be established or
located, which place must be within the Philippines.
The term for which the corporation is to exist not exceeding 50 years.
The names and residences of the incorporators.
The names and addresses of the incorporating directors who must not be less
than five nor more than fifteen.
The amount of share capital, its par value, and the number of shares into
which it is divided. 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 shall be stated
therein.
The amount of share capital or the number of no par shares actually
subscribed, including the names and residences of the subscribers with an
indication of the amount or number of no par shares subscribed and paid by
each.
After the filing of the articles of incorporation, the corporation commences to
have judicial 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.
The corporation must formally organize and commence operations within two
years from the date of its incorporation. Otherwise, its corporate powers shall
cease.
Formal organization requires the adoption of by-laws and the election of officers
by the board of directors pursuant to the by-laws, and taking such steps as are
necessary to enable the corporation to transact the legitimate purpose for which
it was created
BY-LAWS
By-laws 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.
The by-laws shall be adopted and filed with the Securities and Exchange
Commission within one month from the date of incorporation.
Failure to do so shall render the corporation liable for the revocation of
its registration.
CONTENTS OF BY-LAWS
a)
b)
c)
d)
e)
The time, place, manner of calling and rules for meetings of
shareholders and directors. The place of shareholders' meeting must
be the principal place of business.
The number, qualifications, duties, powers, and length of office of
directors. A director must be a registered owner of at least one share
of stock, and majority of the directors must be residents of the
Philippines.
The appointment, duties, powers, compensation and length of office
of corporate officers other than directors.
The manner of issuing share certificates. e. The method of amending
by-laws.
Any other rules governing the acts of officers and directors.
Pre-incorporation subscription requirement
The Corporation Code provides that the Securities and Exchange
Commission shall not register any stock corporation unless 25% of its
authorized number of shares has been subscribed, and at least 25% of
the subscription has been paid.
However, in no case, shall the paid in capital be less thanP5,000.
For example, the authorized share capital is P4,000,000divided into
40,000 shares with par value of P100 per share.
The subscribed share capital must be P1,000,000 which is 25% of
P4,000,000 and the amount paid in must be P250,000 which is 25% of
P1,000,000.
COMPONENTS OF CORPORATION
a)
b)
c)
d)
Corporators are those who compose the corporation whether
shareholders or members or both.
Incorporators are those corporators mentioned in the articles of
incorporation as originally forming and composing the corporation.
Shareholders or stockholders are owners of shares in a stock
corporation. Shareholders may be natural or artificial persons but
only natural persons can be incorporators.
Members are corporators of a nonstock corporation.
BOOKS AND RECORDS OF A CORPORATION
a)
b)
c)
d)
e)
f)
g)
Minutes book contains the minutes of the meetings of the directors and
shareholders.
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.
Books of accounts represent the record of all business transactions. The
books of accounts include normally the journal and the ledger.
Subscription book is a book of printed blank subscription.
Shareholders' ledger is a subsidiary for the share capital issued reporting the
number of shares issued to each shareholder.
Subscribers' ledger is a subsidiary for the subscriptions receivable account
reporting the individual subscription of the subscribers.
Share certificate book is a book of printed blank share certificates.
ORGANIZATION COST
As the name suggests, the term "organization cost" represents costs incurred in
forming or organizing a corporation. Organization cost. Specifically, organization
costs include:
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.
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 clear cut 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:
PHILIPPINE TERM
Capital stock
Subscribed capital stock
Common stock
Preferred stock
Additional paid in capital
Retained earnings (deficit)
Retained earnings appropriated
Revaluation surplus
Treasury stock
IAS TERM
Share capital
Subscribed share capital
Accumulated profits (losses)
Appropriation reserve
Ordinary share capital
Preference share capital
Share premium
Revaluation reserve
Treasury share
DEFINITION OF TERMS
The terms "capital stock", "common stock", "preferred stock", and "treasury stock"
are the terms used in our Philippine Corporation Code.
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.to excess.
Share premium is the portion of the paid in capital representing excess over the
par or stated value.
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
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 item in the
equity section.
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.
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
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.
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
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
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.
The amount of legal capital is determined as follows:
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 of 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.
ILLUSTRATION – MEMORANDUM METHOD
1. An entity was authorized to issue share capital of P4,000,000 divided into 40,000 shares with par
value of P100.
Memo entry - The entity was authorized to issue share capital of P4,000,000, divided into 40,000
shares with par value of P100.
2. Received subscription to 10,000 shares at par.
Subscription receivable
1,000,000
Subscribed share capital
1,000,0000
3. Collected 25% on the above subscription
Cash
250,000
Subscription receivable
250,000
4. Received full payment for 6,000 shares originally subscribed.
Cash
450,000
Subscription receivable
450,000
Subscription price (6,000 x 100)
Less: Partial payment (25% x 600,000)
Balance
600,000
150,000
450,000
5. Issued the share certificates for 6,000 shares which are fully paid.
Subscribed share capital
600,000
Share capital
600,000
The Corporation Code provides that shares are issued only when subscriptions are fully paid.
6. Received a cash subscription for 5,000 shares at par.
Cash
500,000
Share capital
500,000
A cash subscription is directly credited to the share capital account. It is not necessary to set
up a subscription receivable account.
STATEMENT PRESENTATION
If a statement of financial position is prepared, the share capital would be shown under
shareholders' equity.
Share capital, P100 par, 40,000 shares authorized,11,000 shares issued
Subscribed share capital, 4,000 shares
Subscription receivable
SHAREHOLDERS' EQUITY
1,100,000
400,000
( 300,000)
1,200,000
ILLUSTRATION - JOURNAL ENTRY METHOD
Assume the same information in the previous illustration.
1. Unissued share capital
Authorized share capital
4,000,000
2. Subscription receivable
Subscribed share capital
1,000,000
3. Cash
250,000
4,000,000
1,000,000
Subscription receivable
4. Cash
250,000
450,000
Subscription receivable
450,000
5. Subscribed share capital
600,000
Unissued share capital
600,000
Here lies the difference. The issuance of share capital is credited to the unissued share capital
account
6. Cash
500,000
Unissued share capital
500,000
STATEMENT OF PRESENTATION
Authorized share capital, P100 par, 40,000 shares
Unissued share capital, 29,000 shares
Issued share capital
Subscribed share capital, 4,000 shares
Subscription Receivable
SHAREHOLDERS EQUTTY
4,000,000
(2,900,000)
1,100,000
400,000
(300,000)
1,200,000
ISSUANCE OF SHARE CAPITAL
The 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.
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)
Share premium
1,000,000
500,000
Observe that the excess over the par value is credited to share premium.
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)
Share premium
1,000,000
600,000
SHARE ISSUE AT DISCOUNT
When shares are sold at a price which is below par or stated value, they are said
to be issued at a discount.
Our 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.
Note that 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 canceled 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.
For example, if 10,000 shares of P100 par value are sold for P800,000 cash, the
journal entry is:
Cash
Discount on share capital
Share capital
800,000
200,000
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.
ISSUANCE OF SHARE CAPITAL FOR NONCASH CONSIDERATION
The 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 incorporators 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 incorporators or board of directors,
subject to the approval of the Securities and Exchange Commission.
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
ILLUSTRATION
An entity issued 10,000 ordinary shares of P100 par value in exchange for land with a fair
value of P1,500,000. The fair value of the shares issued is P180 per share or a total of
P1,800,000.
If the fair value of the land is used, the journal entry is:
Land
1,500,000
Ordinary share capital
Share premium
1,000,000
500,000
If the fair value of the shares is used, the journal entry is:
Land
1,800,000
Share capital
Share premium
1,000,000
800,000
If the par value of the shares is used, the journal entry is:
Land
1,000,000
Share capital
1,000,000
ISSUANCE OF SHARE CAPITAL FOR SERVICES
Shares may be issued for services as long as the services are already rendered. In
conformity with the legal provision and PFRS 2, 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
Ordinary share capital
Share premium
120,000
100,000
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. b Retained earnings
COSTS 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 prorata 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 for10,000 shares of P100 par
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 receivables, inventories and investments
c. Capital expenditures are recorded as outright expensed
d. Fictitious liabilities are recorded.
DELINQUENT SUBSCRIPTION
Delinquent subscription The 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.
COLLABLE PREFERENCE SHARE
REDEEMABLE PREFERENE SHARE
CONVERTIBLE PREFERENCE SHARE