NATIONAL UNIVERSITY

JUNIOR PHILIPPINE INSTITUTE OF

ACCOUNTANTS

INTERMEDIATE ACCOUNTING 3

SHAREHOLDERS’
EQUITY

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JUNIOR PHILIPPINE INSTITUTE OF
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SHAREHOLDER’S EQUITY
INTERMEDIATE ACCOUNTING 3
PREPARED BY: Maga, Hyacinth T.

DISCLAIMER: This paper is prepared by bonafide NUJPIANS for A.Y. 2021-2022.

The National University Junior Philippine Institute of Accountants together with the BS
Accountancy students of National University made every effort to ensure and help every student
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used in preparing these materials is properly given and cited in every handout. Thus, the production
of these constitutes a fair use of copyrighted material as provided in Sec. 185 of Republic Act 8293
or the “Intellectual Property Code of The Philippines”, which states, “The fair use of a copyrighted
work for criticism, comment, news reporting, teaching including multiple copies for classroom
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purpose and character of the use, including whether such use is of a commercial nature or is for
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uploaded, published, displayed, reproduced, modified, and sold for profit in any form without
permission from the preparers. Furthermore, the violation of these acts is punishable by law. In no
event will the National University Junior Philippine Institute of Accountants together with the
preparers and faculty members be liable to any violation committed by the users of these handouts.
EXCLUSIVE FOR ACCOUNTANCY STUDENTS OF NATIONAL UNIVERSITY ONLY

3 Forms of Business Organization

Form of Business Owner’s claim against assets

Single Proprietorship Capital or Owner’s Equity
Partnership Partner’s Capital or Partner’s Equity
Corporation Shareholder’s Equity or Stockholder’s Equity

Sec 2 of the Corporation Code of the Philippines defines corporation as 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.
Corporation Code – is the general law which governs the creation of private corporations in the
Philippines.
Legal requirement
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.
Formal organization
This requires the adoption of by-laws which is defined as the rules of action adopted by the
corporation for its internal government that should be filed with the Securities and Exchange

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Commission within one month from the date of incorporation and the election of officers by the
board of directors.

Pre-incorporation requirement
Corporation Code provides that SEC shall only register any stock corporation when “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 than P5,000.
Components of corporation
• Corporators – are those who compose the corporation.
• Incorporators – are those corporators who originally formed and composed the
corporation. Only natural persons can be incorporators.
• Shareholders or stockholders – are owners of shares in a stock corporation. They may be
natural or juridical persons and must own at least one share of stock.
• Members – are the corporators in a non-stock corporation.

Shareholder’s Equity
It is the residual interest of owners in the net assets of a corporation measured by the excess of
assets over liabilities. This ownership in a corporation is divided into share capital.
Corporate Capital Structure
Share Capital – is the amount fixed in the articles of incorporation to be subscribed and paid in
or secured by the shareholders of the corporation, either in money or property or services at the
organization of the corporation. It is also called the authorized share capital.
Classes of Share Capital
Preference share – gives the holders a preference as to distribution of profits and assets in
the event of corporate liquidation. It is generally issued with a par value and an annual
dividend rated expressed in percentage or peso amount per share.
Ordinary share – is the primary issue of shares, normally entitling holders to all the basic
rights of a shareholder. When there is only one class of share, all the shares are deemed
ordinary share, whether so designated or not.
Authorized shares – is the maximum number of shares that a corporation can legally issue as
prescribed in its article of incorporation.
Par value – is the value of each share of stock specified in the articles of incorporation and in
the share certificate.
Share certificate – is the instrument or document that evidences the ownership of a share in the
corporation.
Subscribed share capital – is the portion of the authorized share capital that has been subscribed
but not yet fully paid and therefore still unissued.
Share Premium – is the portion of the paid in capital representing excess over the par or stated
value.
Sources of Share Premium
1. Excess over par value or stated value

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2. Resale of treasury shares at more than cost

3. Donated capital

4. Issuance of share warrants

5. Distribution of share dividends
6. 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 the reacquired but
not cancelled.

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. Legal
capital is:
par value shares no-par value share

Ordinary / Preference share capital xxx xxx

Subscribed share capital + xxx + xxx
Excess over stated value xxx

Trust Fund Doctrine – holds that the share capital of a corporation is considered as trust fund for
the protection of creditors, that is why it is illegal to return such to its shareholders during the
lifetime of the corporation.

Accounting for Share Capital Transactions

(1) Memorandum entry method – only a memorandum entry is necessary to record the
authorization to issue share capital.
(2) Journal entry method – a formal journal entry is prepared upon authorization to issue
share capital, debiting Unissued Share Capital and crediting Authorized Share Capital.

Illustration:
Memorandum entry method Journal entry method

(a) Authorization to issue share capital

Authorized to issue xxx shares of capital Unissued share capital xxx

share with total par value of Pxxx. Authorized share capital xxx

(b) Issuance of share capital for cash

Cash xxx Cash xxx

Share capital xxx Unissued share capital xxx

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(c) Subscription of share capital

Subscription receivable xxx Subscription receivable xxx

Subscribed share capital xxx Subscribed share capital xxx

NOTE: Subscription receivable account balance is generally reported as contra equity account.
(d) The subscription has been fully paid Cash
xxx Cash xxx
Subscription receivable xxx Subscription receivable xxx

(e) Issuance of the shares subscribed

Subscribed share capital xxx Subscribed share capital xxx

Share capital xxx Unissued share capital xxx

Issuance of share capital

A. Issuance of share capital at more than par value

Cash xxx When the amount of cash received from the

Share capital xxx issuance of share capital is greater than the
Share premium xxx par value, the excess is
recorded as share premium.

B. Issuance of share capital at less than par value (at a discount)

Cash xxx The discount is not considered a loss to the

Discount on share capital xxx issuing corporation but the shareholder is
Share capital xxx held liable therefore. The account Discount on Share Capital is
deduction from total shareholder’s equity.

NOTE: Corporation Code prohibits the issue of share at a discount

C. Issuance of share capital in exchange for non-cash assets or property

Asset xxx The asset is recorded at its fair market Share capital xxx value or the fair market
value of the shares Share premium xxx issued, whichever is clearly determinable.

D. Issuance of share capital in exchange for services rendered

Professional fees xxx An expense account is debited for the fair Share capital xxx
market value of the services rendered of
Share premium xxx the fair market value of the shares issued, whichever is clearly
determinable.

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E. Issuance of preference and ordinary share capital for a lump-sum amount

Cash xxx
Ordinary share capital xxx The total amount received should be
Share premium – OS xxx allocated to the two classes of share capital
Preference share capital xxx based on the total fair market value of the
Share premium – PS xxx shares issued.

Organization Costs
1. Share issuance costs (recognized) – are directs costs to sell share capital which normally
include legal fees, CPA fees, underwriting fees, etc. Accordingly, PAS 32 provides that
these transactions costs which are directly attributable to the issuance of new shares
shall be deducted from equity. NOTE: Share issuance costs shall be debited to
- Share premium arising from share issuance, if insufficient
- Share issuance costs to be reported as contra equity account

2. Cost of public offering of shares (expensed) – are not incremental costs directly
attributable to the issuance of new shares such as road show presentation and public
relations consultant’s fees, shall be recorded as expense in the income statement.

3. Joint costs (allocated) – are costs that relate jointly to the concurrent listing and issuance
of new shares and listing of old existing shares, which shall be allocated on a prorate
basis.

Watered Share – is share capital issued for inadequate or insufficient consideration and is
recorded as fully paid. In this case, asset is overstated as well as the capital.
Secret Reserve – is the reverse of watered share. It arises when asset is understated or liability is
overstated with the understatement of capital.

Delinquent Subscription
This occurs when the payment for the shares sold on a subscription basis is called by the
board of directors and the subscriber failed to pay the price, the said subscription is deemed
delinquent and shall be advertised for sale in a public auction.
Interested buyers will bid for the smallest number of shares in exchange for the aggregate
amount of the following: (1) unpaid subscription price; (2) accrued interest; (3) expenses incurred
for the sales of shares.

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Illustration:
DAC Corporation is authorized to issue P10 par ordinary share capital. Assume the
following transactions were completed by DAC Corporation with Mr. Danny, a subscriber.

(a) Received subscription from Mr. Cash 45,000

Danny for 10,000 shares at P15 Subscription receivable 105,000
per share. Terms: 30% down and Subscribed ordinary share 100,000
the balance is payable at the end Share premium - OS 50,000
of 60 days.

(b) After several calls, Mr. Danny

failed to pay the balance of his Receivable from highest bidder 105,000
subscription. The shares were Subscription receivable 105,000
deemed delinquent and now
open for bidding.

(c) Expenses for advertising the sale Receivable from highest bidder 3,000
amounted to P3,000, which were Cash 3,000
duly paid by the corporation.

(d) Received bids from the

following:
D 8,000 shares The highest bidder would be, A.
A 6,000 shares NOTE: Highest bidder is the person who is willing
C 7,000 shares to pay the offer price of the delinquent shares for the
smallest number of shares.

(e) The amount due from the highest Cash 108,000

bidder is collected, and Receivable from the highest bidder 108,000
certificates of share capital were Subscribed ordinary share 100,000
accordingly issued.
Ordinary share capital 100,000

Callable preference share Illustration:

– is one which be called in for An entity issued 10,000 callable preference shares
redemption at the option of the with par value of P100 at P120 per share.
corporation.
– has no definite redemption date Cash 1,200,000
– it is an equity instrument Preference share capital 1,000,000
Share premium - PS 200,000

Subsequently, the preference shares are called in at

P150 per share.

Preference share capital 1,000,000

Share premium – PS 200,000
Retained earnings 300,000
Cash 1,500,000

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NOTE: When preference shared are called in: at more than the original issue price, the
excess is charged to the following:
(1) Share premium from original issuance of the preference share

(2) Retained earnings at less than the original price, the

difference is credited to:
(1) Share premium related to ordinary shares

Redeemable preference share Illustration:

– provides for mandatory An entity issued 10,000 preference shares at the par
redemption at the option of the issuer. value of P100 per share. The preference shares
– classified as current or noncurrent have a mandatory redemption by the issuer for
financial liability, depending on the P1,200,000.
redemption date. Cash 1,000,000

Redeemable preference shares 1,000,000

Subsequently, if the preference shares are redeemed

by the issuer for P1,200,000.

Redeemable - PS 1,000,000
Loss on redemption 200,000
Cash 1,200,000

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Take Note:

Pro-Forma of Shareholder’s Equity

Share Capital xxx @par value

Subscribed Share Capital xxx
Subscription Receivable (xxx) contra-equity account
Share Premium xxx
Other Comprehensive Income xxx
Retained Earnings – Appropriated xxx
Retained Earnings – Unappropriated xxx
Treasury Shares (xxx)
TOTAL SHE xxx

- Corporation must formally organize and commence operations within 2 years from the
incorporation.
- Subscribed Share Capital is still unissued if not yet fully paid.
- General rule, share certificate is only issued when the subscription is fully paid.
- A non-par share cannot be issued for less than 5 pesos.
- If there is only 1 class of share capital, it is necessarily an ordinary share.
- It is illegal to pay dividends if the entity has deficit.
- A cash subscription is directly credited to the share capital account.
- A callable preference share has no definite redemption date, it depends on the “call” of the
issuer.
- If shares are issued to extinguish a financial liability, initial measurement should be the fair
value of the shares issued.
- Dividend paid on redeemable preference share shall be accounted as interest expense
– finance cost. Page 7 of 19

Treasury shares – are (1) entity's own share that have been (2) issued originally and then (3)
reacquired but not cancelled.
NOTE: Legal limitation - the corporation can acquire treasury shares only to the extent of
retained earnings balance.

Accounting for Treasury Shares

• Cost Method is used in accounting for treasury shares.

• If acquired for cash, cost is the cash payment.
• If acquired for noncash consideration, cost is the carrying amount of the noncash asset
surrendered.
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NOTE: No gain or loss shall be recognized on the purchase, sale, issue or cancellation of an
entity’s equity instrument.
Retirement of treasury shares
Illustration:
Issuance of treasury shares
An entity acquired 2,000 shares with par
Treasury shares 300,000 of P100 at P150 per share.
Cash 300,000

Reissuance of treasury shares

A. Reissuance at cost
The treasury shares are subsequently
reissued at P150 per share.
Cash 300,000
Treasury shares 300,000

B. Reissuance at more than cost The treasury shares are subsequently

reissued at P200 per share. The excess of
Cash 400,000 the reissue price over the cost is treated
Treasury shares 300,000 as share premium.
Share premium - TS 100,000

C. Reissuance at below cost The treasury shares are subsequently

reissued at P100 per share. The excess of
Cash 200,000 the cost over the reissue price is charged
Retained earnings 100,000 to:
Treasury shares 300,000 (1) Share premium - TS (same class)
(2) Retained earnings Page

A. Retirement results in a gain – the par value exceeds the cost of treasury shares; such gain is
credited to share premium from treasury shares.

Share capital 100,000 1,000 ordinary shares with par of P100 Treasury shares 80,000
are held as treasury at cost of P80,000, Share premium - TS 20,000 subsequently
retired.

B. Retirement results in a loss – the cost of the treasury shares exceeds the par value; such loss
is debited to the following order of priority:
(1) Share premium from original issuance
(2) Share premium from treasury shares
(3) Retained earnings

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Illustration:

Ordinary share capital, 50,000 shares, P100 par 5,000,000

Share premium – original issuance 500,000
Share premium – treasury shares 100,000
Retained earnings 1,000,000
Treasury shares, 5,000 shares at cost 750,000

Ordinary share capital 500,000

Share premium 50,000 NOTE: Share premium from original
Share premium – TS 100,000 issuance is cancelled on a prorata basis
Retained earnings 100,000 in the absence of specific amount
Treasury shares 750,000 identified with the treasury shares.

Disclosure of treasury shares include the following:

a. number of shares held in treasury
b. the restriction on the availability of retained earnings for distribution of dividends equal
to the cost of treasury shares.

Donated Shares – are shares received by the entity from the shareholders by way of donation. It
is actually treasury shares and may therefore be reissued at any price without any discount liability.
NOTE: the reissue or resale of donated shares increases assets and donated capital or share
premium.
Treasury share subterfuge – occurs when excessive shares are issued for a property with the
understanding that the shareholders shall subsequently donate a portion of their shares. Donation
of Capital
1. Received from the shareholders – shall be recorded at fair value with the credit to donated
capital.
2. Received from non-shareholders – gifts of grant of funds that are restricted for property
and equipment additions. It shall be recorded at fair value when received or receivable.
2.1 If given without condition – credited to income
2.2 If given with condition – credited to liability

Assessments on shareholders may be levied when:

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1. Shares are originally issued at discount 2. When the corporation is in dire need of
financial assistance

Share assessment receivable xxx Share assessment receivable xxx

Discount on share capital xxx Share premium - assessments xxx

Recapitalization – occurs when there is a change in the capital structure of the entity. The old
shares are cancelled and new shares are issued.
Typical recapitalizations

(a) Change from par to no-par

Ordinary share capital, P100 par, 50,000 shares 5,000,000

Share premium 500,000
Retained earnings 2,500,000

Ordinary share capital 5,000,000 Case 1: All the 50,000 shares are
Share premium 500,000 called in for cancellation. Instead,
Ordinary share capital 2,500,000 50,000 no-par shares with stated value
Share premium - recapitalization 3,000,000 of P50 are issued.

Ordinary share capital 5,000,000 Case 2: All the 50,000 shares are
Share premium 500,000 called in for cancellation. Instead,
Retained earnings 2,000,000 Ordinary 50,000 no-par shares with stated value
share capital 7,500,000 of P150 are issued.

(b) Change from no-par to par value share

Ordinary share capital, no-par P100 stated value, 50,000 shares 5,000,000
Retained earnings 2,500,000

Ordinary share capital 5,000,000 Case 1: All the 50,000 shares are
Ordinary share capital 2,500,000 called in for cancellation. Instead,
Share premium - recapitalization 2,500,000 50,000 shares of P50 par value are
issued.

Ordinary share capital 5,000,000 Case 2: All the 50,000 shares are
Retained earnings 2,500,000 Ordinary called in for cancellation. Instead,
share capital 7,500,000 50,000 shares of P150 par value are
issued.

(c) Reduction of par value

Ordinary share capital, 50,000 shares, P100 par 5,000,000

Share premium 500,000

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Retained earnings 2,000,000

Ordinary share capital 5,000,000 A recapitalization is effected whereby

Share premium - recapitalization 3,000,000 the par value of P100 is reduced to P80
per share.

(d) Reduction of stated value

Ordinary share capital, 50,000 shares, P100 stated value 5,000,000

Retained earnings 2,000,000

Ordinary share capital 1,000,000 A recapitalization is effected whereby

Share premium - recapitalization 1,000,000 the stated value of P100
is reduced to P80.

(e) Split up – is a transaction whereby the original shares are called in for cancellation and
replaced by a larger number accompanied by a reduction in the par value or stated value.

Example: An entity has 10,000 shares issued and outstanding, with P100 par value. If the
shares are split up 5 to 1, the new capitalization would be 50,000 shares with P20 par value.

(f) Split down – is the reverse of split up. It is a transaction whereby the original shares are
cancelled and replaced by a smaller number accompanied by an increase in the par value
or stated value.

Example: An entity has 10,000 shares issued and outstanding, with P100 par value. If the
shares are split down 5 to 1, the new capitalization would be 2,000 shares with P500 par
value.

Rights Issue – is granted to existing shareholders to enable them to acquire new shares at a
specified price during a specified period.
Share warrants – represent the certificate or instrument evidencing ownership over the rights
issue.
Right of preemption – is the legal right of shareholders to be offered first by the new issued shares
in proportion to their shareholdings before subscriptions are received from the public.

Issuance of rights

Only memorandum entry is required

Expiration of rights

Only memorandum entry is required

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Exercise of rights – a memorandum entry is made for the decrease in the number of shares
claimable through the exercise of rights.
Cash xxx The sale of shares through the
Share capital xxx exercise of rights is then recorded normally.
Take Note:
- The retained earnings must be appropriated to the extent of the cost of treasury shares.
- In reissuance of treasury share below cost, share premium from original issuance is
not touched.
- Treasury shares shall be deducted from total shareholder's equity.
- The receipt of donated shares is simply recorded by means of memorandum entry.
- Before and after the share split, share capital remains the same.
- Share warrants outstanding is reported as part of share premium.
- Under the par value method, any premium from original issuance is cancelled.

Retained earnings – represents the cumulative balance of the following:

A. Net income or loss for the period – net income is added because it increases retained
earnings and net loss is deducted.
B. Dividend distributions – the dividends declared or paid during the year shall be deducted
from retained earnings.
C. Prior period errors – are shown as adjustment to the beginning balance of retained earnings
to arrive at the corrected beginning balance.
D. Changes in accounting policy – this is shown as an adjustment to the beginning balance of
retained earnings.
E. Reclassifications of items of other comprehensive income – reclassified subsequently to
retained earnings.
F. Other capital adjustments

Statement of changes in equity – is a formal statement that shows the movements in the elements
or components of the shareholder’s equity.
A. Total comprehensive income for the period
B. For each component of equity, the effect of changes in accounting policies and correction of
errors.
C. For each component of equity, a reconciliation between the carrying amount at the beginning
and end of the period.

Components of comprehensive income

1. Net income or loss
2. Other comprehensive income which comprises items of income and expense that are not
recognized in profit or loss as required or permitted by PFRS.
a. Unrealized gain or loss on equity investment designated at fair value through other
comprehensive income

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b. Unrealized gain or loss on debt investment measured at fair value through other
comprehensive income
c. Gain or loss from translating the financial statements of a foreign operation
d. Change in revaluation surplus
e. Unrealized gain or loss from derivative contracts designated as cash flow hedge
f. Remeasurements of defined benefit plan, such as actuarial gain or loss recognized in the
current year
g. Change in the fair value attributable to the “credit risk” of a financial liability irrevocably
designated at fair value through profit or loss.

Quasi – reorganization – a permissive but not a mandatory procedure under which a financially
troubled entity restates its accounts and establishes a “fresh start” in accounting sense. Kinds of
Retained Earnings
1. Unappropriated – represent that portion which is free and can be declared as dividends
to shareholders.
2. Appropriated – represent that portion which has been restricted and therefore not
available for any dividend declaration.

3 Appropriation of Dividends
1. Legal appropriation – arises from the fact that the legal capital cannot be returned to the
shareholders until the entity is dissolved and liquidated. Accordingly, a portion of the
retained earnings must be appropriated for an amount equal to the cost of the treasury shares.
2. Contractual appropriation – arises from the fact that the terms of the bond issue and
preference share issue may impose restriction on the payment of dividends.
3. Voluntary appropriation – is a matter of discretion on the part of management.

Accounting for Appropriation

Establishment of appropriation Illustration:

Retained earnings xxx An entity purchased treasury shares at

Retained earnings appropriated xxx a cost of P500,000. Legally, if the
treasury shares are not yet reissued at
year-end, this would require legally an
appropriation of retained earnings.

When appropriation is no longer necessary

Retained earnings appropriated xxx If the treasury shares are subsequently

Retained earnings xxx reissued, the appropriated balance is
cancelled.

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Dividends – are distributions of earning or capital to the shareholders in proportion to their

shareholdings.
2 Classification of Dividends
1. Dividends out of earnings – when dividends are formally declared by the board of directors,
there are:
3 Essential Dates for Accounting Purposes
a. Date of declaration – directors authorized the payment of dividends to shareholders.
b. Date of record – no entry is made but a list of shareholders is made.
c. Date of payment – date which the dividend liability is to be paid.

Forms of dividends out of earnings

A. Cash dividends Illustration:

– are the most common type of dividend. It At the date of declaration

may be expressed: Retained earnings xxx
• certain amount of pesos Dividends payable xxx
• certain percent of the par or SV.
At the date of payment
Dividend payable xxx
Cash xxx

B. Property dividends Illustration:

– are distribution of earnings of the entity in Recognize the dividend payable

the form of noncash assets. Retained earnings xxx
Dividend payable xxx
Measurement of property dividend
payable is at fair value of asset to be Recognize if there is an increase (decrease)
distributed. Retained earnings xxx
Dividend payable xxx

Recognize gain (loss) on distribution

Dividend payable xxx
Investment in equity securities xxx
Gain on distribution xxx

Measurement of property dividend payable is at fair value of asset to be distributed.

NOTE: Dividend payable is initially recognized at the fair value of noncash asset on the date of
declaration and is increased or decreased as a result of change in fair value of the asset at year
end and date of settlement.
Gain on distribution = carrying amount of liability > carrying amount of the asset
Loss on distribution = carrying amount of liability < carrying amount of the asset

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Measurement of noncash asset distributed is at lower of carrying amount and fair value less
cost to distribute.

NOTE: If the fair value less cost to distribute is lower than the carrying amount of the asset, the
difference is accounted for as impairment loss.

C. Scrip dividend Illustration: – is like a note which is formal evidence of

indebtedness. At the date of declaration
Retained earnings xxx
Scrip dividends payable xxx

D. Bond dividend Illustration:

At the date of declaration

Retained earnings xxx
Bond dividends payable xxx

E. Share divide or bonus issue Illustration:

– are distributions in the form of entity’s At the date of declaration

own shares. Retained earnings xxx
Share dividends payable xxx

Issuance of share dividends

Share dividends payable xxx
Share capital xxx

NOTE: If share dividend is less than 20%, retained earnings is equal to the fair value at the date
of declaration.
If share dividend is 20% or more, the par or stated value is capitalized.

2. Dividends out of capital – when capital is returned to shareholders. It is also known as

liquidating dividend.
Dividend as expense – may be presented in the income statement either with interest on other
liabilities or as a separate line item.

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Take Note:
- Retained earnings is also called accumulated profits.
- When retained earnings has a debit balance, it is called deficit or accumulated losses.
- Legally, dividends can be declared only from retained earnings.
- Stock dividends may be declared from premium on par value share.
- The liability for dividend must be recognized on the date of declaration.
- If share dividend is less than 20%, it is small share dividend.
- If share dividend is 20% or more, it is large share dividend.

Share-based compensation plan – is a compensation arrangement whereby the entity’s

employees shall (1) receive shares of capital in exchange for their services or (2) incurs liabilities
to the employees based on the price of its shares.

Accounting for Share-based Compensation

I. Equity settled – entity issues equity instruments in consideration for services received, for
example, share options.
Share options – enables officers to acquire shares of the entity during a specified period upon
fulfillment of certain conditions at a specified price.
Measurement of compensation can be in two methods:
A. Fair value method – compensation is equal to the fair value of the share options, on the date
of grant. NOTE: this is mandated by Philippine Financial Reporting Standard 2 Recognition
of compensation
a. If the share options vest immediately – the employee is not required to complete a
specified period of service. The entity shall recognize the compensation in full, at the date
of grant.

Illustration:
On January 1, 2020, share options are granted to employees to purchase 100,000 ordinary
shares of P50 par value at P60 per share. On this date, the fair value of each share option is P20.

The options are exercisable Salaries – share options 2,000,000

immediately. The employees Share options outstanding 2,000,000
exercised all their share options on
December 31, 2020.

The exercise of the share options on Cash 6,000,000

December 31, 2020 is recorded as: Share options outstanding 2,000,000
Ordinary share capital 5,000,000
Share premium 3,000,000

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b. If the share options do not vest immediately – the employee is required to complete a
specified service period. The compensation expense is recognized over the service period.

Illustration:
On January 1, 2020, share options are granted to officers to purchase 100,000 ordinary
shares of P50 par value at P60 per share. On this date, the fair value of each share option is P15.
The officers are entitled to the share options only after completing two years of service.

The options can only be exercised Salaries – share options 750,000

starting January 1, 2022 and expire Share options outstanding 750,000
one year after.

The exercise of the share options on Salaries – share options 750,000

December 31, 2020 is recorded as: Share options outstanding 750,000

All options are exercised Cash 6,000,000

on December 31, 2022 Share options outstanding 1,500,000
Ordinary share capital 5,000,000
Share premium 2,500,000

B. Intrinsic value method – compensation is equal to the intrinsic value of the share options.
Intrinsic value – is the excess of the market value of the share over the option price.
NOTE: this can only be used only if the fair value of the share option cannot be estimated
reliably.

II. Cash settled – is a share-based payment transaction whereby an entity incurs liability for
services received, for example, share appreciation rights.
Share appreciation right – entitles an employee to receive cash which is equal to the excess
of market value of the entity’s share over a predetermined price for a stated number of shares.
Measurement of compensation
The compensation is based on the fair value of the liability at the reporting date and shall be
remeasured at every year-end until it is finally settled.
NOTE: The fair value of liability is equal to the excess of the market value of share over a
predetermined price for a given number of shares over a definite vesting period.

Recognition of compensation
a. If the share appreciation right vests immediately – the compensation is recognized
immediately on the date of grant.

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ACCOUNTANTS

b. If the share appreciation right do not vest immediately – the compensation is recognized
over the service or vesting period.

Illustration:
An entity granted a share appreciation right to the general manager on January1, 2020.
After a four-year service period, the employee is entitled to receive cash equal to the appreciation
in share over the market value on January 1, 2020. Thus, the market value in January 1, 2020 is
the predetermined price for purposes of determining the compensation.

The quoted prices of the entity’s share are:

January 1, 2020 200

December 31, 2020 210
December 31, 2021 220
December 31, 2022 240
December 31, 2023 250

2020
Salaries 50,000 Market value on (12/31/20) 210
Accrued salaries payable 50,000 Predetermined price 200

Excess 10
Multiply: number of shares
Total compensation
Compensation for 2020/4 50,000

2021
Salaries 150,000 Market value on (12/31/21) 220
Accrued salaries payable 150,000 Predetermined price 200
Excess 20 Multiply: number of shares 20,000
Cumulative compensation 400,000
Compensation for 200,000
2021/4x2
Accrued compensation
Compensation expense

2022
Salaries 400,000 Market value on (12/31/22) 240
Accrued salaries payable 400,000 Predetermined price 200
Excess 40
Multiply: number of shares 20,000
Cumulative compensation 800,000
Compensation for 600,000
2022/4x3

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ACCOUNTANTS

Accrued compensation
Compensation expense

2023
Salaries 400,000 Market value on (12/31/23) 250
Accrued salaries payable 400,000 Predetermined price 200

Excess 50
Multiply: number of shares
Total compensation
Compensation for 2023 Compensation expense

2024
Accrued salaries payable 1,000,000
Cash 1,000,000

NOTE: An employee may have the right to choose between:

a. Cash alternative – cash payment equal to the market value of a certain number of shares
subject to certain conditions.
b. Share alternative – equity shares given to employees.

Accounting for Cash and Share Alternative

- If the entity has the choice of settlement, there is no accounting problem. The entity shall
account for the instrument initially either as liability or equity, but not both.
- If the employee has the right to choose the settlement, the entity is deemed to have issued
a compound financial instrument. Thus, a compound financial instrument is accounted
for as partly liability and partly equity.

“In Accountancy, it is always important to know what, how and why things have
happened.” - DAC

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ACCOUNTANTS

SOURCES:
Peralta, J, Valix, C. A., & Valix, C. (2019). Intermediate Accounting Volume 2
Empleo, P., German, C., & Robles, N. (2014). Fundamentals of Accounting Volume 2:
Partnership and Corporation

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