5.

0 Accounting For Equity Definition : Equity Accounting [Tim] is the investment in another companys is considered equivalent to an interest in equity in the net asset of that company. As the net asset of investee change, so the carrying amount of the investment also changes. So, when the investee operates profitably and increases its net assets. The investor companys books should reflect the carrying amount of the investment increase. While the investee pays the dividend or report the loss, its net asset decrease so in proportionate term does the investor companys asset.

Equity accounts represent the owners' interest in the assets of a business. The owners' interest is the part of assets that is left after all liabilities are paid. Therefore equity is sometimes called Net Assets.[1] 5.1 Types of Equity Accounts Equity accounts may be divided into following important types: : Contributed Capital Part of capital that directly comes from its owners. In case of sole-proprietorship and partnerships, it is the initial capital deposit by owner plus any additional capital deposits during the life of the business. In case of Corporations it is the value of Common Stock at par plus additional paid it capital plus any additional stock issuances. Gained Capital Includes net income by the business less dividends. If the business is earning more than its dividend payments then gained capital accumulated over the years. Revenues The actual money that a business receives or recognizes for its services or sales during an accounting period before any deductions (discounts, sales returns, cost of goods sold, expenses) etc. are made.

Expenses Actually reduce owners' equity so expenses are technically contra equity accounts. 5.2 Equity Accounts List Following are the most common equity accounts for single owner businesses and partnerships: Capital The simplest equity account and it is used for sole proprietorships and partnerships. It includes both contributed capital and invested capital. Drawings Represent the money drawn by the owner of a small business for their personal use.

Following are some of the equity accounts which are used by corporations: Common Stock The basic account used for equity of corporations. It records the portion of contributed capital that relates to common stock issued at par value. Paid-in Capital Most often the amount that stockholders pay for a company stock is higher than par value per share. Since the common stock account only records the portion that relates to par value, therefore the extra amount is recorded and Paid-in Capital account. Treasury Stock Records those share of a company own common stock that is purchased back for some financial reasons. Dividends

Record the amount of money given to stockholders of a business in the form of income sharing. This has same function as of Drawings account of small businesses. Retained Earnings Not all of the earnings of a corporation are distributed among the stockholders. Some are retained form future operations and are recorded in retained earnings account.

5.3 Accounting for Equity Securities Equity security is an investment in stock issued by another company. The accounting for an investment in an equity security is determined by the amount of control of and influence over operating decisions the company purchasing the stock has over the company issuing the stock.

Technically they have three methods for equity security which is cost method, equity method and consolidated financial statements. For example, if less than 20% of the stock is acquired and no significant influence or control exists, the investment is accounted for using the cost method. If 2050% of the stock is owned, the investor is usually able to significantly influence the company it has invested in. Assuming the investor does not control the number of positions on the Board of Directors or hold key officer positions, this investment would be accounted for using the equity method. If the investor has 50% or more of a company's stock, significant influence and control are deemed to exist and the investor reports its results using consolidated financial statements. Although percent of voting stock owned serves as a guideline, the amount of influence and control is used to determine the accounting for equity securities.

Equity securities have some method in threat their transaction:

Cost method The cost method of accounting for stock investments records the acquisition costs in an asset account, equity Investments. As with debt investments, acquisition costs include commissions and fees paid to acquire the stock. As dividends are received, dividend income

is recorded, the entry to record the receipt of the dividend increases (debits) cash and increases (credits) dividend revenue.

Equity investments accounted for by using the cost method are classified as either trading securities or available-for-sale securities, and the value of the investment is adjusted to market value. When an equity investment accounted for under the cost method is sold, a gain or loss is recognized for the difference between its acquisition cost and the proceeds received from the sale.

Equity method According to IAS 28 (Investment in associates and joint venture (2011), it define equity method is a method of accounting whereby the investment is initially recognized at cost and adjusted thereafter for the post-acquisition change in the investors share of the investees net asset. The investors profit and loss include its share of the investees profit or loss and the investors other comprehensive income includes its share of the investees other comprehensive income.

We also may understand the other definition of equity method of accounting for stock investments is used when the investor is able to significantly influence the operating and financial policies or decisions of the company it has invested in. Given this influence, the investor adjusts the value of its equity investment for dividends received from, and the earnings (or losses) of, the corporation whose stock has been purchased. The dividends received are accounted for as a reduction of the investment value because dividends are a partial return of the investor's investment. According to Accounting Principles board opinion No. 18, The Equity method of accounting for investment in common stock [James E. Morris, 2004], summarize the process of accounting investment using equity method as: a) An investor initially records an investment in the stock of an investee at cost and adjusts the carrying amount of investment to recognize investors share of earning or losses of the investee after the date of acquisition.

b) The amount of adjustment is included in the determination of net income by the investor and such amount reflect adjustment similar to those made in preparing consolidated statement including adjustment to eliminate intercompany gains and loss and to amortize. If any difference between investor cost and underlying equity in net assets of the investee at the investees capital c) The investment of investor is also adjusted to reflect the investors share of changes in the investees capital. d) Dividend receive from an investee reduce the carrying amount of investment. e) A series of operating losses of an investee or other factor might indicate that a decrease in value of the investment has occurred that is other than temporary. That should be recognize even though the decrease in value is in excess of what would otherwise be recognized by application of equity method.

I will show the illustration of the transaction within this method [2] : When Company A (the investor) has significant influence over Company B (the investee) but not majority voting powerCompany A accounts for its investment in Company B using the equity method of accounting. Company B is considered an unconsolidated subsidiary of Company A in such circumstances, from Company A's perspective, but could be a freestanding, publicly traded corporation. A company is generally considered to have significant influence, but not control, when it owns 20% 50% of the voting interest in the unconsolidated subsidiary. The company does not actually record the subsidiary's assets and liabilities on its balance sheet [James E. Morris, CPA, 2004]. Rather, the Investment in Affiliate (or Equity Investment) non-current asset account on the balance sheet serves as a proxy for the Company A's economic interest in Company B's assets and liabilities. Record initial investment dr. Investment in affiliate cr. Cash Company A is entitled to a portion of Company B's earnings in proportion to Company A's economic ownership of Company B's stock. Company A records its

proportionate share of the subsidiary's earnings as an increase to the Investment in Affiliate account on its balance sheet. These earnings may be distributed as cash dividends, or retained by Company B. To the extent Company A's share of Company B's earnings are distributed as cash dividends, the Investment in Affiliate account is reduced by the amount of the dividend because the dividend is considered a return of capital. The net effect is that the Investment in Affiliate account increases by Company A's proportionate share of the undistributed earnings of Company B. Record equity income dr. Investment in affiliate cr. Equity income in affiliate

Record cash dividend dr. Cash cr. Investment in affiliate Cash taxes are paid by the investor only on cash dividends received. The undistributed earnings give rise to a deferred tax liability payable when the earnings are ultimately distributed, or the investment is liquidated. Recall that taxes on dividend income may be offset by the Dividends Received Deduction. Whether, you apply the Dividends Received Deduction to deferred taxes on undistributed earnings is a judgment call. Accountants will generally advise you not to, since applying the Dividends Received Deduction to undistributed earnings implies an expectation that those earnings will ultimately be distributed. However, companies rarely pay "catch-up" dividends. In other words, a company is unlikely to distribute earnings in the future that it declined to distribute in the past. So, undistributed earnings rarely qualify for the Dividends Received Deduction because their future distribution is not expected. If you do expect undistributed earnings to be paid out in the future, then you could make a case for applying the Dividends Received Deduction to the undistributed earnings in the current period.

Record taxes on equity income dr. Income tax expense cr. Cash (current tax expense) cr. DTL (deferred tax expense) In some cases, the deferred tax liability related to undistributed earnings from an equity investment can grow quite large over time. Monetizing the investment after the deferred tax liability has grown large can trigger a large tax bill that: (i) (ii) Must be weighed against the benefits of monetization, and May limit the investor's strategic options with respect to the disposition of the stake. PNC Financial faced this dilemma in evaluating monetization options for its sizeable investment in Black Rock. Suppose Example A Simple Equity Method Example Company A buys 40% of Company B's voting common stock for $500. What journal entry does Company A make to record the purchase? Record Investment dr. Investment in affiliate cr. Cash $500 $500

The following quarter, Company B reports net income of $200 and announces a $40 dividend. What journal entries does? Company A make to record its proportionate share of Company B's earnings and the cash dividend?

Record Equity Income dr. Investment in affiliate cr. Equity income in affiliate [= 40% $200] $80 $80

Record Cash Dividend dr. Cash [= 40% $40] cr. Investment in affiliate $16 $16

Assume Company A's tax rate is 35%, and that Company A may fully utilize the applicable Dividends Received Deduction . What journal entry does Company A make to record its tax expense related to its investment in Company B?

Record Income Tax Expense dr. Income tax expense cr. Cash [= $16 (1 80%) 35%] cr. DTL [= ($80 $16) 35%] $23.5 $1.1 $22.4

Consolidated financial statements A company that owns greater than 50% of another entity is called the parent company. The company whose stock is owned is called the subsidiary company. A parent company uses the equity method to account for its investment in its subsidiary. When financial statements are prepared, the assets and liabilities (balance sheet), revenues and expenses (income statement), and cash flows (cash flow statement) of both the parent company and subsidiary company are combined and shown in the same statements. These statements are called consolidated balance sheets, consolidated income statements, and consolidated cash flow statements together they are called consolidated financial statements and represent the financial position, results of operations and cash flows of the parent company and any other companies it controls.

5.4 Issues Equity

In this subtopic we will discuss about right issue, bonus issue, share splits and share buyback. I. Right Issue A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings, therefore rights issue is a way of raising new cash from shareholders (this is an important source of new equity funding for publicly quoted companies). Legally a rights issue must be made before a new issue to the public. This is because existing shareholders have the right of first refusal (preemption right) on the new shares. By taking these preemption rights up, existing shareholders can maintain their existing percentage holding in the company. The price at which the new shares are issued is generally much less than the prevailing market price for the shares. The main reason is to make the offer relatively attractive to shareholders and encourage them either to take up their rights or sell them so the share issue is "fully subscribed". Shareholders who do not wish to take up their rights may sell them on the stock market or via the firm making the rights issue, either to other existing shareholders or new shareholders. The buyer then has the right to take up the shares on the same basis as the seller. Other factors to consider in rights issues :

a. Issue Costs Rights issues are a relatively cheap way of raising capital for a quoted company since the costs of preparing a brochure, underwriting commission or press advertising involved in a new issue of shares is largely avoided. However, it still costs money to complete a rights issue. As many of the costs of the rights issue are fixed (e.g. accountants and lawyers fees) the % cost falls as the sum raised increases.

b. Shareholder reactions Shareholders may react badly to firms continually making rights issues as they are forced either to take up their rights or sell them. They may sell their shares in the company, driving down the market price.

c. Control Unless large numbers of existing shareholders sell their rights to new shareholders there should be little impact in terms of control of the business by existing shareholders.

d. Unlisted companies Unlisted companies often find rights issues difficult to use, because shareholders unable to raise sufficient funds to take up their rights may not have available the alternative of selling them where the firm's shares are not listed. This could mean that the firm is forced to rely on retained profits as the main source of equity, or seek to raise venture capital or take on debt. [3]

II. Bonus Issue Bonus Issues, also known as Scrip Issue or Capitalisation Issue, are an issue of free additional shares to the existing shareholders of the company in direct proportion to their existing shareholding in the company. For instance, a 1-for-5 Bonus Issue will entitle an existing shareholder to receive 1 Bonus Share at no cost for every 5 ordinary shares held. While Bonus Issues result in an increase of shares in circulation, existing shareholders continue to retain their proportionate ownership in the company. Bonus Issues are made out of a companys share premium or distributable reserves, such as accumulated profits or retained earnings which are profits built up over the years not paid out in dividends but retained in the business. This transfer from the companys reserves into paid-up share capital is thus known as capitalisation of reserves where an increase in shareholders equity is offset by a fall in the capital reserves or retained

earnings. Since no new funds are raised in a Bonus Issue exercise, the companys net worth or equity as measured by the share capital and reserves remains unchanged.

In a Bonus Issue, the nominal value (where applicable), also known as face or par value of the companys shares does not change.

Companies pursue Bonus Issue for the following reasons: To offer existing shareholders part of their respective interests in the undistributed profits retained in the company in the form of shares instead of cash distribution so as to conserve cash for business operations or expansions. To promote more active trading of the companys shares in the stock market through a reduction in the market price per share within a more reasonable range as a result of the enlarged share capital base so that they are within the reach of the retail investors at large who might otherwise give the stock a miss due to its initial high price levels. To serve as a strong indication to the stock market of the companys financial strength through its continued ability to service its larger equity base and future growth prospects, thereby possibly enhancing the credit standing and hence borrowing capacity of the company.[4]

III. Share Split With using a share split the firm can reduce the share price by increasing the number of shares outstanding. For example, a 3 for 2 share split means that for every 2 shares an investor owns, a third share is issued for free. With a share split, the firm aims to keep the stock price within a trading range that provides the most liquidity. No journal entry is needed, as the number of shares increases by some factor, while at the same time the par value per share decreases by the same factor, leaving the value of common shares unchanged. a) All per-share based figures decrease proportionally. b) Share splits are performed so that the share price is in a normal trading range. c) A reverse split is used when the share price is very low.

IV. Share Buy Back The provisions regulating buy back of shares are contained in Section 77A, 77AA and 77B of the Companies Act,1956. These were inserted by the Companies (Amendment) Act,1999.

Objectives of Buy Back: Shares may be bought back by the company on account of one or more of the following reasons a) To increase promoters holding. b) Increase earnings per share. c) Rationalize the capital structure by writing off capital not represented by available assets. d) Support share value. e) To thwart takeover bid. f) To pay surplus cash not required by business.

Actually, the best approach to maintain the share price in a bear run is to buy back the shares from the open market at a premium over the prevailing market price.

a) Resources of Buy Back. A Company can purchase its own shares from : Free reserves. Where a company purchases its own shares out of free reserves, then a sum equal to the nominal value of the share so purchased shall be transferred to the capital redemption reserve and details of such transfer shall be disclosed in the balance-sheet. Securities premium account. Proceeds of any shares or other specified securities. A Company cannot buy back its shares or other specified securities out of the

proceeds of an earlier issue of the same kind of shares or specified securities.

b) Conditions of Buy Back: The buy-back is authorized by the Articles of association of the Company. A special resolution has been passed in the general meeting of the company authorising the buy-back. In the case of a listed company, this approval is required by means of a postal ballot. Also, the shares for buy back should be free from lock in period/non transferability. The buy back can be made by a Board resolution If the quantity of buyback is or less than ten percent of the paid up capital and free reserves. The buy-back is of less than twenty-five per cent of the total paid-up capital and fee reserves of the company and that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capital in that financial year. The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-back. There has been no default in any of the following: i. In repayment of deposit or interest payable thereon. ii. Redemption of debentures, or preference shares. iii. Payment of dividend, if declared, to all shareholders within the stipulated time of 30 days from the date of declaration of dividend. iv. Repayment of any term loan or interest payable thereon to any financial institution or bank. There has been no default in complying with the provisions of filing of annual return, payment of dividend, and form and contents of annual accounts. All the shares or other specified securities for buy-back are fully paidup. The buy-back of the shares or other specified securities listed on any recognised stock exchange shall be in accordance with the regulations.

The buy-back in respect of shares or other specified securities of private and closely held companies is in accordance with the guidelines as may be prescribed.

Disclosures in the explanatory statement i. A full and complete disclosure of all material facts; ii. The necessity for the buy-back; iii. The class of security intended to be purchased under the buy-back; iv. The amount to be invested under the buy-back; and v. The time-limit for completion of buy-back

Prohibition of Buy Back : i. Through any subsidiary company including its own subsidiary companies. ii. Through any investment company or group of investment companies.[5]

5.5 Statement of equity changes A statement of changes in equity shows all changes in owners equity for a period of time and summarizes the movement in the equity accounts during the year namely share capital, share premium, retained earnings, revaluation surplus, unrealized gains on investments, etc. The purpose of the statement of changes in equity is to provide readers with the useful information on how the capital or fund of an entity is utilized and used. Since it shows the movements of equity and accumulated earnings and losses, the readers can depict on where the companys equity came from and where did it go.

According to MFRS 110, 106A state that for each component of equity an entity shall present, either in the statement of changes in equity or in the notes, an analysis of other comprehensive income by item. MFRS 110, 106 stat the information that presented in the statement of changes in equity. An entity shall present a statement of changes in equity as required by paragraph 10. The statement of changes in equity includes the following information:

a) Total comprehensive income for the period, showing separately the total amount attributable to owners of the parent and to non- controlling interests

b) For each component of equity, the effect of retrospective application or retrospective restatement recognized in accordance with MFRS 108

c) [deleted by IASB]

d) For each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes resulting from: i. Profit or loss ii. Other comprehensive income iii. Transaction with owners in their capacity as owners, showing separately contribution by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control.

Information to be presented in the statement of changes in equity or in the notes. [6]

This is the explanation from difference accounting standard, which is IAS. Refer to IAS 1, this statement of financial reporting is one the five components of complete financial statements (balance sheet, income statement, statement of changes in equity, statement of cash flow and notes to financial statements. IAS 1 requires an entity to present a statement of changes in equity as a separate component of the financial statements. The statement must show: [IAS 1.96] a) Profit or loss for the period b) Each item of income and expense for the period that is recognized directly in equity, and the total of those items c) Total income and expense for the period (calculated as the sum of (a) and (b)), showing separately the total amounts attributable to equity holders of the parent and to minority interest

d) For each component of equity, the effects of changes in accounting policies and corrections of errors recognised in accordance with IAS 8 The following amounts may also be presented on the face of the statement of changes in equity, or they may be presented in the notes: [IAS 1.97] a) Capital transactions with owners b) The balance of accumulated profits at the beginning and at the end of the period, and the movements for the period c) A reconciliation between the carrying amount of each class of equity capital, share premium and each reserve at the beginning and at the end of the period, disclosing each movement [7] A statement of changes in equity is an important component of financial statements since it explains the composition of equity and how has it changed over the year. Typical information we can get from a statement of changes in equity include: a) The amount of new share capital issued b) The amount of dividend paid during the year to shareholders c) The amount by which PPE is valued up or valued down d) The amount of net income earned during the year e) The amount of net income retained during the year f) Any movement in the unrealized loss or gain reserve and reserve for changes in foreign exchange gain or loss, etc. [8]

REFERENCE: Website & articles: [1] [2] [3] https://macabacus.com/accounting/equity-method (surf on 25 October 2013 ) http://www.iasplus.com/en/projects/research/equity-method (surf on 25 October 2013 ) http://www.tutor2u.net/business/finance/finance_sources_equity_rights.asp (surf on 26. Oct. 2013) [4] [5] [6] [7] http://blog.shareinvestor.com/bonus-issues/ (surf on 25. Oct. 2013) http://www.legalserviceindia.com/articles/shares.htm (surf on 25.Oct. 2013) Malaysian Financial Reporting Standard 101 http://businessaccent.com/2009/02/04/knowing-and-understanding-what-is-statement-ofchanges-in-equity/ (surf on 25. Oct.2013 ) [8] http://accountingexplained.com/financial/statements/equity-statement (surf on 25. Oct. 2012) [9] www.accounting.utep.edu sglandon c12 c12b.pdf (surf on 25. Oct.2013 ) www.public.asu.edu bac524 long-terminvestments.pdf (surf on 25. Oct.2013 ) www2.fiu.edu ielsh001 C 4201 ... Chapter%2001 S .pdf (surf on 25. Oct.2013 )

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Teks books : 1. A. Zaimah; S. Hasnah; A.A. Saliza; A.B. Fathiyyah; S. Norfaiezah; S. Zakiah; M.A. Arifatul Husna; H. Azizi@Hamizi; F.A. Mohd & C.Y. Tan (2010). Financial Reporting Standards Requirement and Applications in Financial Accounting and Reporting. Kuala Lumpur. Malaysia.:Prentice Hall 2. Tim Sutton, Corporate Financial Accounting and reporting(2000), Financial Times (Prentice Hall) , page 362-414 (stockholder equity) & page 424-454 (equity accounting and consolidation) 3. Peter Jubb, Stephen Haswell, Ian Langfield-Smith(2010), Company Accounting-5th Edition, Cengage Learning Australia, Page 452-462 (Introduction of equity accounting ) 4. James E. Morris, CPA, CFA, Accounting for Mand A, Equity, AND Credit Analysis (2004), McGrawHill Inc, page 1-20 (Equity method of accounting for investment)