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MODULE 4 PACKET
ELEC 2 – Valuation Concepts and Methods
MODULE 4 SHAREHOLDER’S EQUITY

Welcome to Module 4
In this module, we will discuss the concept of a corporation and accounting for transactions pertaining to
shareholder’s equity.

CONSULTATION HOURS:
Virtual time: During your class schedule (either Monday or Tuesday)
Phone or Messenger: Every Thursday from 8am to 11am and 1pm to 4pm

MODULE 4 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Know the elements of shareholders’ equity
2. Distinguish ordinary and preference share capital
3. Understand the accounting for share capital, share issuance cost and cost of public offering of shares
4. Know the accounting for treasury shares
5. Identify typical recapitalizations
6. Understand the recognition of rights issue and share warrants

COURSE CONTENT FOR MODULE 4:

ACTIVITY DESCRIPTION TIME TO COMPLETE

Assigned Reading Shareholder’s Equity 1.5 hour
Lecture Discussion Treasury shares, rights issue, share split 1.5 hour
Activity Problem Solving 2 hours
Quiz Summative quiz for module 4 (to be announced) 1 hour

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ASSIGNED READING

A corporation is an artificial being created by operation of law, having the right of succession and the
powers, attributes and properties expressly authorized by law or incident to its existence.

A corporation is a legal or juridical person with a personality separate and apart from the individual
members or shareholders.

The general law which governs the creation of private corporations is Republic Act 11232 otherwise known
as Revised Corporation Code.

Books and records of a corporation

1. Minutes book contains the minutes of the meetings of the directors and shareholders.
2. 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.
3. Books of accounts present the records of all business transactions. They include the journal and
the ledger.
4. Subscription book is a book of printed a blank subscription.
5. Shareholders’ ledger is a subsidiary for the share capital issued reporting the number of shares
issued to each shareholder.
6. Subscribers’ ledger is a subsidiary for the subscriptions receivable account reporting the individual
subscription of the subscribers.
7. Share certificate book is a book of printed blank share certificates.

Organization cost

These are costs incurred in forming or organizing a corporation. They include legal fees in connection with
the incorporation, such as drafting of articles of incorporation and by-laws and corporation registration;
incorporation fees; and 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 provides that start-up costs which include legal and secretarial costs in establishing a legal entity
shall be recognized as expenses when incurred. Organization cost shall be expensed immediately with the
exception of share issuance costs.

Shareholders’ equity

Shareholders’ equity or stockholders’ equity is the residual interest of owners in the net assets of the
corporation measured made excess of assets over liabilities.

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.

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Share premium is the portion of the paid in capital representing excess over the par or stated value.
Sources 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

Capital stock is the amount fixed in the articles of incorporation (known as authorized share capital) 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.

Ordinary shareholders have the same rights and privileges. They enjoy no preference over each other.
They have no fixed or specific return on investment since they are dependent on the operations of the
entity.

Preference shareholders have preference on claims on dividends and net assets during liquidation. They
have a limited or fixed return on investment. Thus a holder of P1,000 par value, 12% preference share, is
entitled to a declared annual dividend of P120.

Legal capital arises from the issuance of share capital which cannot be returned to the shareholders during
the lifetime of the corporation.

Trust fund doctrine holds that the share capital of a corporation is considered as trust fund for the
protection of creditors. It is illegal to return such legal capital to shareholders during the lifetime of the
corporation. Therefore, since dividends come from retained earnings, it is illegal to pay dividends if the
entity has a deficit.

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Accounting for share capital

a. Memorandum method – no entry is made to record the authorized share capital. But when it 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 it is issued, it is credited “unissued share
capital” account.

Memorandum Method Journal Entry Method

An entity was authorized The entity was authorized to issue share Unissued share capital 100,000
to issue share capital of capital of P100,000 divided into 1,000 Authorized share capital 100,000
P100,000 with par value shares with par value of P100
of P100.
Received subscription to Subscription rcvble 50,000 Subscription rcvble 50,000
500 shares at par Subscribed share capital 50,000 Subscribed share capital 50,000
Collected 25% on the Cash 12,500 Cash 12,500
subscription Subscription receivable 12,500 Subscription receivable 12,500
Received full payment for Cash 15,000 Cash 15,000
200 shares originally Subscription receivable 15,000 Subscription receivable 15,000
subscribed. (200xP100=20,000) – 25%*20,000 partial
Issued share certificates Subscribed share capital 20,000 Subscribed share capital 20,000
for the 200 fully paid Share capital 20,000 Unissued share capital 20,000
shares
Received a cash Cash 40,000 Cash 40,000
subscription for 400 Share capital 40,000 Unissued share capital 40,000
shares at par

Statement Presentation - Memorandum Statement Presentation – JE Method

Share capital, P100 par, 1,000 60,000 Authorized share capital, P100 par, 100,000
authorized shares, 600 shares issued 1,000 shares
Subscribed share capital, 300 shares 30,000 Unissued share capital (40,000)
Subscription receivable (22,500) Issued share capital 60,000
Shareholder’s equity 67,500 Subscribed share capital, 300 shares 30,000
Subscription receivable (22,500)
Shareholder’s equity 67,500

Issuance of share capital

5,000 ordinary shares of P200 par value Cash 1,250,000

are sold at P250 per share Ordinary share capital 1,000,000
Share premium 250,000

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.

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Share issued at discount. Discount on share capital is a deduction from total shareholder’s equity.

5,000 ordinary shares of P200 par value Cash 700,000

are sold for P700,000 Discount on share capital 300,000
Ordinary share capital 1,000,000

Issuance of share capital for noncash consideration

When 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 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

Shares can be issued for services already rendered, recorded at the fair value of such services or fair value
of shares issued, whichever is reliably determinable.

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.

Transaction costs directly attributable to the issuance of new shares shall be deducted from equity, net of
any related income tax benefit. Share issuance cost is debited to share premium arising from the share
issuance, unless if the premium is insufficient, then “share issuance costs” account is debited and reported
as a contra-equity account deducted either from share premium from previous share issuance or retained
earnings.

Transaction costs may relate jointly to the concurrent listing and issuance of new shares, and of existing
shares which needs to be allocated. Joint costs include audit and other professional advice, opinion of
counsel, tax opinion, fairness opinion and valuation report, and prospectus design and printing.

Illustration. An entity undertakes an initial public offering or IPO for the listing and issuance of 700,000
new shares and listing of 300,000 old existing shares. The entity incurred the following costs:

Documentary stamp tax 25,000

Fairness opinion and valuation report 125,000
Tax opinion 100,000
Newspaper publication 200,000
Listing fee 300,000
Other joint costs 275,000

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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Watered share is share capital issued for inadequate or insufficient consideration or less than par or stated
value but the share is issued as fully paid. As a result, the asset and corresponding capital are overstated.

A land with FV of P1,000,000 is received for 10,000 shares Land 1,200,000

with P120 par value. Both are overstated. Share capital 1,200,000

It is illegal to issue a share for less than the par or stated value. Thus, the accounts should be corrected
by debiting Discount on share capital and crediting Land for P200,000.

Secret reserve arises when asset is understated or liability is overstated with an understatement of capital.
It arises because of excessive provision for depreciation, depletion, amortization and doubtful accounts;
excessive writedown of receivables, inventories and investments; capital expenditures are recorded as
outright expense; and fictitious liabilities are recorded.

Recall:

Delinquent Subscription

Highest Bidder

Callable preference share is one that can be called in for redemption at a specified price at the option of
the corporation. Unlike redeemable preference share, it does not have a definite redemption date. A
callable preference share is an equity instrument rather than a financial liability.

When preference shares are called in at more than the original issue price, the excess is debited to share
premium from original issuance of the preference shares first, and if depleted to retained earnings.
But when the call price over is less than the original issue price, the difference is credited to share premium
related to ordinary shares.

Redeemable preference shares provide for mandatory redemption by the issuer for a fixed or
determinable amount at a future date. It gives the holder the right to require the issuer to redeem the
instrument for a fixed or determinable amount at a future date. It is classified as current or noncurrent
financial liability depending on the redemption date.

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Callable Preference Share

Redeemable Preference Share

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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Treasury Shares

Requisites to qualify as treasury shares:

a. The shares must be the entity’s own shares.
b. Shares must have been issued originally. Treasury shares can be legally reissued at a discount
without any discount liability while unissued shares must be issued at least at par or stated value.
c. Shares are reacquired but not canceled.

The Revised Corporation Code provides that no corporation shall redeem, repurchase, or reacquire its own
shares, of whatever class, unless it has adequate amount of unrestricted retained earnings to support the
cost of said shares.

Accounting for Treasury Shares

The cost method is used in accounting for treasury shares, regardless of whether the shares are acquired
below or above the par or stated value. Subsequently, the treasury shares may be reissued or sold at cost,
more than cost or below cost.

An entity acquired 3,000 shares with P100 par Treasury shares 450,000
value at P150 per share. Cash 450,000
Reissuance at Cost. The treasury shares are Cash 450,000
subsequently reissued at P150 per share. Treasury shares 450,000

An entity acquired 3,000 shares with P100 par Treasury shares 450,000
value at P150 per share. Cash 450,000
Reissuance at more than cost. The treasury Cash 600,000
shares are subsequently reissued at P200 per Treasury shares 450,000
share. Share premium – treasury 150,000

Reissuance at below cost. The excess of the cost over the reissue price is charged to the following in
order of priority: share premium from treasury shares of the same class, and retained earnings.

If there are no previous transactions involving Cash 360,000

treasury shares, assume the 3,000 shares issued Retained Earnings 90,000
at P150 were reissued at P120 Treasury shares 450,000

Share premium
from original
issuance is not
affected

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The cost method is the acceptable method in accounting for treasury shares. The par value method is not
acceptable because of the legal requirement that retained earnings must be appropriated to the extent of
the cost of treasury shares.

Retirement of treasury shares

When treasury shares are retired, it may result to gain when the par value exceeds the cost of treasury
shares – credited to share premium from treasury shares.

If 1,000 ordinary shares with par of P100 are held Ordinary share capital 100,000
as treasury at a cost P75,000 and subsequently Treasury shares 75,000
retired Share premium – treasury 25,000

If the retirement results in a loss wherein the cost exceeds the par value, the loss is debited first to share
premium from original issuance, then to share premium from treasury shares and lastly to retained
earnings.

The share premium from

original issuance is canceled
on prorate basis if there is no
specific amount identified
with treasury shares

5,000/50,000 shares
X P500,000 share premium

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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The resale or reissue of the treasury donated shares is not credited entirely to donated capital. The sale
price shall be used in correcting the overvalued asset and share capital.

An entity issued 1,000 ordinary shares of P500 par value Land 500,000
for land with a legally determined fair value of P400,000 Ordinary share capital 500,000

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Donation of capital

Contributions, including shares of an entity, received from shareholders shall be recorded at fair value
with the credit going to donated capital.

Capital gifts or grants shall be recorded at fair value when received or receivable.

Capital gifts or grants from non-shareholders are generally subsidies and credited to income. Otherwise,
the offsetting credit shall be a liability account until the restrictions are met.

Assessments on shareholders

Assessment may be levied on shareholders when share are originally issued at discount (receivable from
the shareholder) or when the corporation is in dire need of financial assistance.

A discount on share capital of P80,000 and the Cash or share assessment rcvble 80,000
same is charged to the shareholder by virtue of Discount on share capital 80,000
assessment made by the BOD

When the corporation is in dire need of financial assistance, the shareholders can vote to assess
themselves a certain amount per share owned.

A corporation with 10,000 shares issued and Cash or share assessment rcvble 100,000
outstanding and shareholders are assessed P10 Share premium - assessments 100,000
per share

RECAPITALIZATION

Recapitalization occurs when there is a change in the capital structure of the entity. The old shares are
canceled and new shares are issued. They can be done by:

a. Change from par to no-par

b. Change from no-par to par
c. Reduction of par value
d. Reduction of stated value
e. Split up
f. Split down

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Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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Reduction of stated value. Ordinary share capital, 50,000 shares, at P100 stated value = P5 million while
Retaining earnings at P2 million. A recapitalization is effected when the stated value is reduced to P90.

Ordinary shares capital (50,000 x P10) 500,000

Share premium – recapitalization 500,000

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Share split – only memorandum entry is required

1. Split up or share split proper

2. Split down or reverse share split

RIGHTS ISSUE

Rights issue is granted to existing shareholders to enable them to acquire new shares at a specified price
during a specified period. It is also known as stock right.

No entry is required when share warrants are issued to existing shareholders because these warrants are
issued usually without consideration. The entity only makes a memorandum entry to indicate to the number
of rights issued to shareholders and the number of shares that can be purchased through the exercise of
the rights. When the rights expire, only a memorandum entry is required.

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Illustration. An entity issued 20,000 preference shares of P100 par value for P3,250,000 with 20,000
warrants to acquire 10,000 shares, P50 par value ordinary shares at P60 per share. The market values
on the date of issuance: Preference share ex-warrant 120
Warrant 10

Allocation of
issue
price

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LET’S TRY!!!
https://www.peardeck.com/googleslides

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ACTIVITY

1.

2.

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3.

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4.

5.

6.

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