Financial Management

Introduction to Shareholder’s Equity

•​ The Philippine Corporation Code defines a 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.”

•​ A corporation is formed by at least 5 but not exceeding 15 natural persons, all of legal age and a majority of
whom are residents of the Philippines.

•​ The entity’s articles of incorporation must be authorized by the Securities and Exchange Commission (SEC).

•​ The articles of incorporation states, among other things, the entity’s authorized capital stock , which is the
maximum number of shares that the entity can issue. Any excess share issued is deemed illegal. In order to issue
shares in excess of the authorized capital stock, the entity must amend its articles of incorporation.

•​ To amend the articles of incorporation, a majority vote of the board plus a vote by shareholders representing at
least two-thirds (2/3) of the outstanding share capital is needed. After ratification, the amended articles of
incorporation are filed with the SEC and shall become effective only upon approval by the SEC.

•​ At least 25% of the entity’s authorized capitalization should be subscribed and at least 25% of the total
subscription must be paid upon subscription. In no case shall the paid-up capital be less than five thousand pesos
(₱5,000).

Components of Stockholders’ Equity

Definition of Terms

Authorized share capital- represents the maximum number of shares fixed in the entity’s authorized articles of
incorporation that can be subscribed and issued to shareholders.
Unissued share capital- represents the portion of the authorized capital not yet issued and is still available for
subscription and issuance.

Share capital- represents the portion of the authorized share capital that I already issued

Subscribed share capital- represents the portion of the authorized capital that is subscribed but not yet issued

Subscription- a contract between the purchaser of shares and the issuer in which the purchaser promises to buy shares
of the issuing company’s stocks

Subscription receivable- represents the unpaid portion of the subscription price. Subscription receivable is presented as
a deduction from the related subscribed hare capital (contra equity account)

Discount on share capital- represents the excess of par value (or stated value) over the consideration received from the
issuance of shares

Capital liquidated- represents the liquidating dividends declared by a wasting asset corporation

•​ The following transactions affect the accounting for a corporation’s equity:

1.​ Authorization, subscription, issuance, acquisition, reissuance and retirement of shares

2.​ Origination of other equity instruments, such as share options, detachable warrants, and equity component of
compound financial instruments.

3.​ Distributions to owners

4.​ Transactions giving rise to “other components of equity”

5.​ Recapitalization and Quasi-reorganization

Accounting for share capital

1.​ Memorandum method - Only a memorandum is made for the authorized capitalization. Subsequent issuances of
shares are credited to the share capital account.

2.​ Journal entry method - The authorized capitalization is recorded by crediting “authorized share capital” and
debiting “unissued share capital.” Subsequent issuances of shares are credited to “unissued share capital.”

Classes of share capital

•​ Share capital is basically classified into two, namely:

1.​ Ordinary share capital (common stock); and

2.​ Preference share capital (preferred stock).

Four basic rights of ordinary shareholders

1.​ Right to attend and vote in shareholders’ meetings

2.​ Right to purchase additional shares (also known as preemptive right or stock right)

3.​ Right to share in the corporate profits (also known as right to dividends)
 4.​ Right to share in the net assets of the corporation upon liquidation

Share premium

•​ Share premium (additional paid-in capital) arises from various sources which include the following:

1.​ Excess of subscription price over par value or stated value.

2.​ Excess of reissuance price over cost of treasury shares issued.

3.​ Issuance or origination of other equity instruments, such as share options, detachable share warrants, and
equity components of compound financial instruments.

4.​ Distribution of “small” stock dividends.

5.​ Quasi-reorganization and recapitalization.

Legal capital

•​ Legal capital is the portion of contributed capital that cannot be distributed to the owners during the lifetime of
the corporation unless the corporation is dissolved and all of its liabilities are settled first. Legal capital is
computed as follows:

1. For par value shares, legal capital is the aggregate par value of shares issued and subscribed.

2. For no-par value shares, legal capital is the total consideration received or receivable from shares issued or
subscribed. Total consideration refers to the subscription price inclusive of any amount in excess of stated value.

Share issuance costs

•​ “The transaction costs of an equity transaction are accounted for as a deduction from equity to the extent they
are incremental costs directly attributable to the equity transaction that otherwise would have been avoided.”
(PAS 32.7)

Treasury shares

•​ Treasury shares (treasury stocks) are an entity’s own shares that were previously issued but are subsequently
reacquired but not retired. Under the Corporation Code, an entity may reacquire its previously issued shares only
if it has sufficient unrestricted retained earnings.

Accounting for treasury shares

•​ The cost method is used in accounting for treasury share transactions. Under this method, the reacquisition and
subsequent reissuance of treasury shares are recognized and derecognized, respectively, at cost.
Retirement of shares

Stock rights

•​ Stock rights are issued to existing ordinary shareholders in relation to their preemptive rights. The stock rights
enable existing shareholders to protect their current ownership interests by acquiring new shares issued by the
corporation before such shares are offered to new investors.

•​ Stock rights are recorded through memo entry only because stock rights are issued to existing shareholders
without consideration. An entry is made only when the rights are exercised or recalled.

Donated capital

1.​ Donation from shareholders – recognized directly in equity (i.e., credited to share premium).
2.​ Donation from the government – recognized as government grant (see discussion in Intermediate Financial
Accounting Part 1B).

3.​ Donation from other sources – recognized in profit or loss (i.e., income) when (a) the conditions attached to the
donation are fulfilled or reasonably expected to be fulfilled, (b) the donation becomes receivable, and (c) the
criteria for asset recognition is met.

4.​ Cash – recognized at the amount of cash received or receivable.

5.​ Noncash assets – recognized at the fair value of the noncash assets

6.​ Entity’s own shares – initially recorded through memo entry. Donated capital is recognized only when the
donated shares are subsequently reissued. This is because no asset is generated from the donated shares until
they are subsequently reissued. If the donated shares are not to be resold, the entity should effect a formal
reduction of its authorized capital by retiring the shares received.