CHAPTER 20

SHAREHOLDERS' EQUITY
TECHNICAL KNOWLEDGE
To know the elements of shareholders' equity and the equivalent IFRS term.
To distinguish ordinary share capital and preference share capital.
To know the recognition and measurement of share capital
To understand the accounting treatment of share issuance
cost and cost of public offering of shares.
To know the recognition of a delinquent subscription.

Introduction
The three forms of business organization are single proprietorship, partnership and corporation.
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 of shareholders.
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
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 Republic
Act 11232 otherwise known as Revised Corporation Code.
Section 10 of the Revised Corporation Code provides that any person, partnership, association or
corporation, simply or jointly with others but not more than fifteen in number may organize a
corporation for any lawful purpose of purposes.
Provided, that natural persons who are licensed to practice a profession and partnerships or
associations organized for the purpose of practicing a profession shall not be allowed to organize
as a corporation unless otherwise provided under special laws.
A corporation with a single shareholder is considered a One Person Corporation.
Section 3 provides that corporations formed or organized may be stock or nonstock corporations.
Stock corporations are those which have capital stock divided into shares. All other corporations
are nonstock corporations

Contents of Articles of Incorporation

All corporations shall file with the Securities and Exchange Commission the Articles of
Incorporation containing substantially the following matters:
a. The name of the corporation.
b. The purpose or purposes for which the corporation is formed.
c. The place where the principal office of the corporation is to be established or located which
place must be within the Philippines.
d. The term of existence if the corporation has not elected perpetual existence.
e. The names, nationalities and residence addresses of the incorporators.
f. The number of directors which shall not be more than fifteen or the number of trustees which
may be more than fifteen.
g. The names, nationalities and residence addresses of persons who shall act as directors until the
first regular directors are duly elected.
h. If it be a stock corporation, the amount of authorized capital stock, and the number of shares
into which it is divided, the par value of each share, names, nationalities and residence addresses
of original subscribers, amount subscribed and paid by each on the subscription.
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 value shall be stated therein.
i. If it be a nonstock corporation, the amount of its capital, the names, nationalities and residence
addresses of the contributors and amount contributed by each.
j. Such other matters consistent with law and which the incorporators may deem necessary and
convenient.
Certificate of incorporation
The corporation commences to have juridical 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
Formal organization requires the adoption of bylaws which shall be filed with the Securities and
Exchange Commission
Bylaws
Bylaws 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.
Among others, a private corporation may provide the following in its bylaws:
a. The time, place and manner of calling and conducting regular or special meeting of directors,
trustees, shareholders or members
b. The number, qualifications, duties, responsibilities, length of office and compensation of
directors or trustees
c. The appointment, duties, responsibilities, length of office and compensation of corporate
officers, other than directors or trustees
d. The manner of issuing stock certificates
Minimum capital stock
Section 12 of the Revised Corporation Code provides that stock corporation shall not be
required to have a minimum capital stock, except as otherwise specifically provided by special
law

Components of corporation
a. Corporators are those who compose the corporation whether shareholders or members or
both.
b. Incorporators are those corporators mentioned in the articles of incorporation as originally
forming and composing the corporation.
c. Shareholders or stockholders are owners of shares in a stock corporation.
Under the Revised Corporation Code, shareholders and incorporators may be natural or artificial
persons.
d. Members are corporators of a nonstock corporation.
Books and records of a corporation
a. Minutes book contains the minutes of the meetings of the directors and shareholders.
b. 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.
c. Books of accounts represent the record of all business transactions. The books of accounts
include normally the journal and the ledger.
d. Subscription book is a book of printed blank subscription.
e. Shareholders' ledger is a subsidiary for the share capital issued reporting the number of shares
issued to each shareholder.
f. Subscribers' ledger is a subsidiary for the subscriptions receivable account reporting the
individual subscription of the subscribers.
g. 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
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 clearcut 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
Ordinary share capital
Preference share capital
Share premium
Accumulated profits (losses)
Appropriation reserve
Revaluation reserve
Treasury share

Definition of terms
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.
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 Revised
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 capital
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:
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 100.
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 1,000,000
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) 600,000
Less: Partial payment (25% x 600,000) 150,000
Balance 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 Revised 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 1,100,000
Subscribed share capital, 4,000 shares 400,000
Subscription receivable (300,000)
Shareholders' equity 1,200,000

Illustration - Journal entry method

Assume the same information in the previous illustration
1. Unissued share capital 4,000,000
Authorized share capital 4,000,000
2. Subscription receivable 1,000,000
Subscribed share capital 1,000,000
3. Cash 250,000
Subscription receivable 250,000
4. Cash 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 presentation
Authorized share capital, P100 par, 40,000 shares 4,000,000
Unissued share capital, 29,000 shares (2,900,000)
Issued share capital 1,100,000
Subscribed share capital, 4,000 shares 400,000
Subscription receivable (300,000)
Shareholders' equity 1,200,000

Issuance of share .capital

The Revised 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 state 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) 1,000,000
Share premium 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) 1,000,000
Share premium 600,000

Share issued 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.
The Revised 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 800,000
Discount on share capital 200,000
Share capital 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.
Treasury shares will be discussed in a later chapter.

Issuance of share capital for noncash consideration

The Revised 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 shareholders 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 stockholders or board of directors, subject to the approval of the Securities and
Exchange Commission.
The Revised Corporation Code further provides that shares shall not be issued in exchange for
promissory notes or future service.
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 1,000,000
Share premium 500,000

If the fair value of the shares is used, the journal entry is:
Land 1,800,000
 Share capital 1,000,000
Share premium 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 120,000
Ordinary share capital 100,000
Share premium 20,000

Share issuance costs

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. 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 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 between the newly issued and listed shares, and the newly shares, and
listing of old existing shares shall be allocated 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
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

Cost of public offering

Listing fee 300,000
Share issuance costs
Documentary stamp tax 25,000
Newspaper publication 200,000
Total 225,000
Joint costs
Fairness opinion and valuation report 125,000
Tax opinion 100,000
Other joint costs 275,000
Total joint costs 500,000
The cost of public offering is expensed immediately.
Share listing fee 300,000
Cash 300,000
The share issuance costs shall be recorded as follows:
a. If the new shares are issued at more than par:
Share premium 225,000
Cash 225,000

b. If the new shares are issued at par:

 Share issuance costs 225,000
Cash 225,000

Allocation of joint costs

Outstanding Fraction Allocated
Newly issued and listed shares 700,000 7/10 350,000
Newly listed old existing shares 300,000 3/10 150,000
1,000,000 500,000
Share premium 350,000
Stock listing fee 150,000
Cash 500,000

Watered share
Watered share is share capital issued for inadequate 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 for 10,000 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 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 writedown of receivables, inventories and investments.
c. Capital expenditures are recorded as outright expense.
d. Fictitious liabilities are recorded.

Delinquent subscription
The Revised 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 may 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.
Who is the highest bidder?
The highest bidder is the person who is willing to pay the offer price of the delinquent shares for
the smallest number of shares. The offer price normally includes the following:
a. Balance due on the subscription
b. Interest accrued on the subscription due
c. Expenses of advertising and other costs of sale

Illustration
X subscribed for 10,000 shares at par P100, paying P600,000 as initial payment. The balance of
the subscription was called and X failed to pay. Consequently, the subscription was declared
delinquent.
The offer price is P450,000 including the balance due on the subscription, interest and costs of
sale. There are three bidders who are willing to pay the offer price, namely:
 А 4,500 shares
B 5,000 shares
C 6,000 shares

Evidently, A is the highest bidder. Thus, all the 10,000 shares shall be deemed fully paid.
Accordingly, A gets 4,500 shares, and X, the original subscriber, gets 5,500 shares.

No bidders
In case where there are no bidders, the corporation may purchase for itself the delinquent shares.
The delinquent subscriber is then released from liability with regard to the subscription which is
deemed fully paid.
1. X subscribes for 10,000 shares at par P100.
Subscription receivable 1,000,000
Subscribed share capital 1,000,000
2. X pays P600,000.
Cash 600,000
Subscription receivable 600,000
3. The subscription balance is called and X defaults.
No entry.
4. The corporation pays P30,000 for expenses incurred in connection with the auction of the
delinquent shares.
Advances on delinquency sale 30,000
Cash 30,000
5. The offer price comprises:
Subscription receivable 400,000
Interest 20,000
Expenses on delinquency sale 30,000
Total 450,000
6. There are no bidders. As stated earlier, the corporation may bid in the absence of a bidder or a
highest bidder.
Journal entries
a. Treasury shares 450,000
Subscription receivable 400,000
Interest income 20,000
Advances on delinquency sale 30,000
b. Subscribed share capital 1,000,000
Share capital 1,000,000

Callable preference share

A callable preference share is one which can be called in for redemption at a specified price at
the option of the corporation.
As distinguished from a redeemable preference share, a callable preference share has no definite
redemption date as this is dependent on the "call" of the issuer.
A callable preference share is an "equity instrument" rather than a financial liability because the
option of the issuer to redeem the share for cash does not satisfy the "textbook" definition of a
financial liability.
Illustration
An entity issued 10,000 callable preference shares with par value of P100 at P120 per share. The
journal entry to record the issuance of the preference shares is as follows:
Cash (10,000 x 120) 1,200,000
Preference share capital (10,000 x 100) 1,000,000
Share premium – PS 200,000

Subsequently, the preference shares are called in at P150 per share. The journal entry to record
the call is:
Preference share capital 1,000,000
Share premium – PS 200,000
 Retained earnings 300,000
Cash (10,000 x 150) 1,500,000

When preference shares are called in at more than the original issue price of the preference
shares, the excess is debited to retained earnings.
Accordingly, the excess of the call price over the par value of the preference shares is charged to
the following:
a. Share premium from original issuance of the preference share
b. Retained earnings
On the other hand, when preference shares are called in at less than original issue price, the
difference is simply credited to share premium related to ordinary shares.

Redeemable preference share

PAS 32, paragraph 18, defines redeemable preference share as:
a. A preference share that provides for mandatory redemption by the issuer for a fixed or
determinable amount at a future date.
b. A preference share that gives the holder the right to require the issuer to redeem the
instrument for a fixed or determinable amount at a future date.
A redeemable preference share shall be classified as current or noncurrent financial liability
depending on the redemption date.

Illustration
An entity issued 10,000 preference shares at the par value of P100 per share. The preference
shares have a mandatory redemption by the issuer for P1,200,000.
The journal entry to record the issuance of the redeemable preference shares is:
Cash (10,000 x 100) 1,000,000
Redeemable preference shares 1,000,000

If a dividend of P100,000 is paid to the redeemable preference shareholders, the journal entry is
Interest expense 100,000
Cash 100,000
Subsequently, if the preference shares are redeemed by the issuer for P1,200,000, the journal
entry is:

Redeemable preference shares 1,000,000

Loss on redemption 200,000
Cash 1,200,000
PAS 32, paragraph 36, provides that the difference between the redemption price and the
financial liability is accounted for as gain or loss on redemption.

Another illustration
On January 1, 2020, an entity issued preference shares for cash equal to the par value of
P6,000,000.
The preference shares are redeemable at the option of the preference shareholders.
No dividends are to be paid on these shares but the preference shareholders have the right to
require the issuer to redeem the shares on January 1, 2022 for P6,615,000.
The interest rate implicit in this agreement is 5% which is compounded annually.
Journal entries
2020
Jan. 1 Cash 6,000,000
Redeemable preference shares 6,000,000
Dec. 31 Interest expense 300,000
Accrued interest payable
(5% x 6,000,000) 300,000
2021
Dec. 31 Interest expense 315,000
Accrued interest payable
(5% x 6,300,000) 315,000
2022
Jan. 1 Redeemable preference shares 6,000,000
Accrued interest payable 615,000
 Cash 6,615,000

Convertible preference share

A convertible preference share is one which gives the holder the right to exchange the holdings
for other securities of the issuing corporation.
A preference shareholder may convert the preference share into ordinary share because
operations are successful and earnings on the ordinary share are unlimited.
A preference shareholder may convert the preference share into bonds which is actually a change
of equity from that of an owner to that of a creditor. Normally, preference share is convertible
into ordinary share.
Illustration
Preference share capital, 10,000 shares, P100 par 1,000,000
Ordinary share capital, 200,000 shares authorized,
100,000 shares issued, P30 par 3,000,000
Share premium – PS 200,000
Share premium – ordinary 1,000,000
Retained earnings 2,000,000

Case 1
The preference share is converted into ordinary share in the ratio of one preference share for
three ordinary shares.
Preference share capital 1,000,000
Share premium – PS 200,000
Ordinary share capital (30,000 x 30) 900,000
Share premium – ordinary 300,000
Case 2
The preference share is converted into ordinary share in the ratio of one preference share for five
ordinary shares.
Preference share capital 1,000,000
Share premium – PS 200,000
Retained earnings 300,000
Ordinary share capital (50,000 x 30) 1,500,000