UNIT 8

AUDIT OF EQUITY ACCOUNTS

Estimated Time: 4.5 HOURS

Discussion Questions 8-1

1. Enumerate transactions affecting the owners equity transaction of a typical
company (e.g. sole proprietorship, partnership, and corporation).
2. Summarize the provisions of PFRS 2 Share-based Payments and other relevant
accounting standards concerning the recognition, measurement, presentation and
disclosure of stockholders equity and related accounts.
3. Prepare a detailed audit program in auditing stockholders equity and related
accounts.
4. Refer to Auditing & Assurance Services. 4th Edition, McGraw-Hill/Irwin by
Louwers, Ramsay, Sinason and Strawser. Answer Multiple Choice 10.22, 28, 3235 and 45 (pages 403 to 406).

Problem 8-1: Analysis of Equity Accounts

A partial list of accounts and ending account balances taken from the trial balance of
AERON Incorporated on December 31, 2013 is shown as follows:
Account
Accumulated profits unappropriated
Bonds Payable
Ordinary Shares Subscribed
Long term investments in equity securities
Additional paid in capital on ordinary shares
Premium on bonds payable
Authorized Ordinary Shares at P10 par value
Preference Shares subscribed
Additional paid-in capital on preference shares
Authorized preference shares at P50 par value
Gain on sale of treasury shares
Unrealized increase in value of AFS
Ordinary Share Warrants Outstanding
Unissued Ordinary Shares
Unissued Preference Shares
Cash Dividends payable-preference
Donated Capital
Reserve for bond sinking fund
Reserve for depreciation
Revaluation Increment
Subscription receivable preference (noncurrent)
Subscription receivable common (noncurrent)
Required: Compute for the following:
1. Ordinary shares issued
2. Preference shares issued
3. Additional Paid In Capital
4. Total Contributed Capital
5. Total Legal Capital
6. Total Stockholders Equity
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Amount
P410,000
220,000
50,000
210,000
460,000
30,000
900,000
45,000
112,000
400,000
4,000
3,000
20,000
500,000
100,000
50,000
25,000
220,000
150,000
100,000
15,000
20,000

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Problem 8-2 Treasury Stock Transactions

The stockholders equity of RTW Corporation as of December 31, 2013 was as

follows:
Share Capital, P10 par, authorized 300,000 shares;
250,000 shares issued and outstanding
2,500,000
Share Premium
3,750,000
Accumulated Profits
1,800,000
During the year, the following transactions transpired:
a. On June 1, 20011, RTW reacquired 40,000 shares of its common stock at
P40 per share.
b. Of the 40,000 reacquired shares, 15,000 were sold at P45, 17,000 at P30,
and 1,000 were retired.
Required: Compute for the following:
a.
b.
c.
d.
e.

Share capital
Treasury Shares
Share premium
Share premium from treasury shares
Accumulated Profits

Problem 8-3 Stockholders Equity Transactions

The shareholders equity section of Kumander Diosa Corporations statement of
financial position as of December 31, 2013, is as follows:
Ordinary share capital (P6 par, 250,000
shares authorized, 147,500 issued and
outstanding)
Share premium
Total paid-in capital
Unappropriated retained earnings
Appropriated retained earnings
Total retained earnings
Total shareholders equity

885,000
442,500

963,500
350,000

1,327,500

1,313,500
P 2,641,000

The Company had the following shareholders equity transactions during 2010:
Jan. 15 Completed the building renovation for which P350,000 of retained earnings
had been restricted. Paid the contractor P328,300, all of which is capitalized.
Mar. 3

Issued 50,000 additional ordinary shares for P1

1 per share.

May 18 Declared a dividend of P1.50 per share to be paid on July 31, 2014, to
shareholders of record on June 30, 2014.
June 19 Approved additional building renovation to be funded internationally. The
estimated cost of the project is P400,000, and retained earnings are to be
restricted for that amount.
July 31 Paid the dividend.

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Nov. 12 Declared a property dividend to be paid on December 31, 2014, to

shareholders of record on November 30, 2014. The dividend is to consist of
18,300 shares of Chanel Corporation ordinary shares that are currently
recorded in Armanis books at P9 per share.
Dec. 31 Reported P673,500 of net income on December 31, 2014 income statement.
In addition, the shares were distributed in satisfaction of the property
dividend.
Required:
a. Prepare the journal entries to record the transactions in 2014.
b. Determine the balance of the following as of December 31, 2014:
i. No. of Shares Issued and Outstanding
ii. Ordinary share capital account
iii. Share premium account
iv. Retained earnings
v. Total shareholders equity

Problem 8-4: Shareholders Equity Transactions

Burberry Company was formed on July 1, 2011. It was authorized to issue 600,000
shares of P10 par value ordinary shares and 200,000 shares of 8 percent P25 par
value, cumulative and non-participating preference shares. Burberry Company has a
July 1 June 30 fiscal year.
The following information relates to the shareholders equity accounts of Burberry
Company:
Ordinary Shares
Prior to the 2013-2014 fiscal year, Burberry Company had 250,000 of outstanding
ordinary shares issued as follows:
1. 210,000 shares were issued for cash on July 1, 2011, at P33 per share.
2. On July 24, 2011, 10,000 shares were exchanged for a plot of land which cost
the seller P160,000 in 2001 and had an estimated market value of P530,000
on July 24, 2011.
3. 30,000 shares were issued on March 1, 2013; the shares had been
subscribed for P46 per share on October 31, 2012.
During the 2013-2014 fiscal year, the following transactions regarding ordinary
shares took place:
2013
Oct. 1

Four thousand shares were issued for cash at P48 per share.

Nov. 30 Burberry purchased 4,600 of its own ordinary shares on the open market at
P39 per share.
Dec. 15 Burberry declared a 5% stock dividend for shareholders of record on
January 15, 2014, to be issued on January 31, 2014. Burberry was having a
liquidity problem and could not afford a cash dividend at that time.
Burberrys ordinary shares were selling at P52 per share on December 15,
2013.
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2014
June 20 Burberry sold 1,100 of its own ordinary shares that it had purchased on
November 30, 2013, for P47,000.
Preference Shares
Burberry issued 100,000 preference shares at P47 per share on July 1, 2012.
Cash Dividends
Burberry has followed a schedule of declaring cash dividends in December and June
with payment being made to shareholders of record in the following month. The cash
dividends which have been declared since inception of the company through June 30,
2014, are shown below:
Declaration Date
12/15/12
06/15/13
12/15/13

Ordinary Shares
P0.30 per share
P0.30 per share
---

Preference Shares
P1.50 per share
P1.50 per share
P1.50 per share

No cash dividends were declared during June 2014 due to the companys liquidity
problems.
Retained Earnings
As of June 30, 2013, Burberrys retained earnings account had a balance of
P1,830,000. For the fiscal year ending June 30, 2014, Burberry reported a net
income of P130,000.
In March 2013, Burberry received a term loan from Dior Cartier Bank. The bank
requires Burberry to establish a sinking fund and restrict retained earnings for an
amount equal to the sinking fund deposit. The annual sinking fund payment of
P150,000 is due on April 30 each year; the first payment was made on schedule on
April 30, 2014.
Required:
a. Journal entries to record the transactions from 2011 to 2014.
b. Compute the balances of the following accounts as of June 30, 2014:
i. Ordinary share capital account
ii. Share premium ordinary shares (including treasury shares)
iii. Unappropriated retained earnings
iv. Number of ordinary shares issued and outstanding
v. Total shareholders equity

Problem 8-5: Dividends and Equity Balances

Sir Cle, Corp. (SCC) has the following amounts in the shareholders equity section as
of December 31, 2013:
Preference shares, 10%, P10 par value (100,000
shares authorized, 25,000 shares issued)
Ordinary shares, P5 par (50,000 shares
authorized 30,000 shares issued)
Shares premium
Retained Earnings
Total
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250,000.00
150,000.00
104,000.00
750,000.00
1,254,000.00
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The following transactions occurred during the year:

a. Issued 6,500 preference shares at P17 per share.
b. Purchased 4,500 shares of its own outstanding ordinary shares for P18 per
share.
c. Reissued 1,200 treasury shares for equipment valued at P30,000.
d. Declared a 5% stock dividend on the outstanding ordinary shares when the
shares were selling for P11 per share.
e. Paid the annual 2009 P1 per share cash dividend on preference shares and a
P0.50 per share cash dividend on ordinary shares. These dividends had been
declared on December 31, 2013.
f. Issued stock dividend.
g. Declared the annual 2014 P1 per share cash dividend on preference shares
and the P0.50 per share cash dividend on ordinary shares. These dividends
are payable in 2015.
h. Appropriated retained earnings for plant expansion, P200,000.
i. Appropriated retained earnings for treasury shares.
The net income for 2014 was P620,000.
Required:
Compute for the following balances as of December 31, 2014:
1.
2.
3.
4.
5.

Preference shares
Ordinary shares
Share premium
Treasury shares
Unappropriated Retained Earnings

Problem 8-6: Quasi-Reorganization

Shown below are Davidoff Companys condensed statements of financial position
immediately before and one year after it had completed a quasi-reorganization.

Current assets
Property, plant, and equipment
(net)
Total assets
Ordinary shares
Share premium
Retained earnings
Total shareholders equity

Dec. 31, 2013

(before quasireorganization)
P
1,200,000
P
P

5,600,000
6,800,000

7,400,000
730,000
(1,330,000)
P
6,800,000

Dec. 31, 2014

P

1,670,000

4,140,000
5,810,000

5,890,000
160,000
(240,000)
5,810,000

In 2014, Davidoff reported net income of P650,000 and depreciation expense of

P470,000. The quasi-reorganization on December 31, 2013, included the write down
of the companys inventories by P490,000. No purchases or sales of property, plant,
and equipment items and no share transactions occurred in 2014.

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Required:
Prepare all the journal entries made at the time of the quasi-reorganization.

Problem 8-7: Share Options

At the beginning of year 1, the entity grants 130 shares each to 550 employees,
conditional upon the employees remaining in the entitys employ during the vesting
period. The shares will vest at the end of year 1 if the entitys earnings increase by
more than 18 percent; at the end of year 2 if the entitys earning increase by more
than an average of 13 percent per year over the two-year period; and at the end of
year 3 if the entitys earnings increase by more than an average of 10 percent over
the three-year period. The shares have a fair value of P36 per share at the start of
year 1, which equals the share price at grant date. No dividends are expected to be
paid over the three-year period.
By the end of year 1, the entitys earnings have increased by 14 percent, and 40
employees have left. The entity expects that earnings will continue to increase at a
similar rate in year 2, and therefore expects that the shares will vest at the end of
year 2. The entity expects, on the basis of a weighted average probability, that a
further 34 employees will leave during year 2, and therefore expects that 476
employees will vest in 130 shares each at the end of year 2.
By the end of year 2, the entitys earnings have increased by only 10 percent and
therefore the shares do not vest at the end of year 2. 32 employees have left during
the year. The entity expects that a further 28 employees will leave during year 3, and
that the entitys earnings will increase by at least 6 percent, thereby achieving the
average of 10 percent per year.
By the end of year 3, 24 employees have left and the entitys earnings had increased
by 8 percent, resulting in an average increase of 10.67 percent per year. Therefore,
454 employees received 130 shares at the end of year 3.
Required:
Compute for the amount of remuneration expense at the end of years 1-3.

Problem 8-8: Share Options

At the beginning of 2013, Lancome Company grants share options to each of its 125
employees working in the sales department. The share options will vest at the end of
2015, provided that the employees remain in the entitys employ, and provided that
the volume of sales of a particular product increases by at least an average of 5
percent per year. If the volume of sales of the product increases by an average of
between 10 percent and 15 percent each year, each employee will receive 300 share
options. If the volume of sales increases by an average of 15 percent or more, each
employee will receive 400 share options.
On grant date, Lancome Company estimates that the share options have a fair value
of P34 per option. Lancome Company also estimates that the volume of sales of the
product will increase by an average of between 10 percent and 15 percent per year.
The company also estimates on the basis of weighted average probability that 19
percent of employees will leave before the end of 2013.
By the end of 2013, seven employees have left and the company still expects that a
total of 19 employees will leave by the end of 2015. Product sales have increased by
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12 percent and the company expects this rate of increase to continue over the next
two years.
By the end of 2014, a further six employees have left. The entity now expects only
four more employees will leave during 2015. Product sales have increased by 18
percent. The company now expects that sales will average 15 percent or more over
the three-year period.
By the end of 2015, a further three employees have left. The entitys sales have
increased by an average of 16 percent over the three years.
Required:
a. Compensation expense, 2013
b. Compensation expense, 2014
c. Compensation expense, 2015

Problem 8-9: Share options with cash alternatives

Titus Company grants to an employee the right to choose either 5,500 phantom
shares1 or 7,000 shares. The grant is conditional upon the completion of three years
of service. If the employee chooses the share alternative, the shares must be held
for three years after the vesting date.
At grant date, the entitys share price is P83 per share. At the end of years 1, 2 and 3,
the share price is P84, P87 and P91 respectively. The entity does not expect to pay
dividends in the next three years. After taking into account the effects of the postvesting transfer restrictions, the entity estimates that the grant date fair value of the
share alternative is P81 per share.
Required:
a. Compensation expense, year 1
b. Compensation expense, year 2
c. Compensation expense, year 3

Problem 8-10: Share Appreciation Rights

On January 1, 2013, Royce Corporation grants 120 cash share appreciation rights
(SAR) to each of its 200 employees on condition that the employee remain in its
employ for the next three years.
During 2013, 14 employees left and the company estimates that a further 24 will
leave during 2014 and 2015. During 2014, 10 employees left and the company
estimates that a further 8 will leave during 2015. During 2015, 8 employees left. At
the end of 2015, 60 employees exercised their SAR. At the end of 2016, another 42
employees exercised their SAR. At the end of 2017, the remaining employees
exercised their SAR.

Phantom shares represent the right of an employee to receive cash payments equivalent to
5,500 shares as if the employee were given an actual share of stock in the company. The
employee never actually owns shares and thus obtains no shareholder rights under the plan.
1

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The entity estimates the fair value of the SAR at the end of each year in which a
liability exists as show below. At the end of 2015, all SAR held by the remaining
employees vest. The intrinsic values of the SAR at the date of exercise (which equal
the cash paid out) at the end of 2015, 2016, and 2017 are also shown below:
Year

Fair Value

2013
2014
2015
2016
2017

P 28
30
33
41

Intrinsic Value

P 36
39
48

Required:
a.
b.
c.
d.

Compensation expense in 2014

Compensation expense in 2015
Compensation expense in 2016
Compensation expense in 2017

Problem 8-11 Comprehensive Problem

In your first year audit of LA Bulldogs Inc., stockholders equity accounts for the audit
year 2014, the following schedule of the companys equity account as of December
31, 2013 was presented by your client:
Ordinary Share Capital, P100 par, 200,000 shares authorized,
50,000 shares issued and outstanding, options to purchase
10,000 shares at P100 per share held by employees, no value
assigned to these options
Share Premium
Accumulated Profits

P5,000,000

1,000,000
3,000,000

Your examination disclosed the following:

a. The options referred to above were granted to each of its 100 employees on
January 1, 2012 which shall vest three years thereafter provided employees
do not leave the Company. It further provides that sales should increase at
least by an average of 10%. If the sales increase by average of 10% per year,
employees receive 100 share options. If the sales increase by an average of
15%, each employee will receive 200 share options. If sales increase by an
average of at least 20% per year, each employee shall receive 300 options.
The fair value of each share option was 30. No employees left the company
and sales increase by 13% in 2012, 13% in 2013 and 19% in 2015.
b. On May 1, 2014, the Company issued bonds of P5,000,000 at 120 giving
each P1,000 bond a warrant enabling the holder to purchase 4 shares at 120
per share for a one year period. The market value of the bond ex-warrant is
105.
c. On June 1, 2014, half of the warrants were exercised relating to the bonds
issued last May 2014.

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d. On August 1, the company issued rights to shareholders, permitting holders to

acquire for a 60-day period, 1 share at P130 with every 5 rights submitted.
Shares were selling at P150. All but 5000 of these rights were exercised.
e. The company declared P5 cash dividends on December 15, 2011. These
remained unpaid as of year-end.
f.

Net income amounted to P2,500,000 in 2011.

Prepare and audit working paper showing the retrospective adjustment to retained
earnings (accumulated profits) and a rollforward analysis of the Companys
Stockholders Equity.

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