CHAPTER 15

Equity
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the corporate form 3. Explain the accounting and
and the issuance of shares. reporting issues related to
2. Explain the accounting and dividends.
reporting for treasury shares. 4. Indicate how to present and
analyze equity.

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 Components of Equity

Ordinary
OrdinaryShares
Shares
Account
Account
Contributed
Contributed Share
SharePremium
Premium
Capital
Capital Account
Account
Preference
PreferenceShares
Shares
Account
Account

Two Primary
Sources of Retained
RetainedEarnings
Earnings
Account
Account
Equity Assets –
Liabilities =
Less:
Less: Equity
Treasury
TreasuryShares
Shares
Account
Account

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 EQUITY

Equity is often subclassified on the statement of financial

position into the following categories
1. Share capital. What do we call them
under GAAP?
2. Share premium.

3. Retained earnings.

4. Accumulated other comprehensive income.

5. Treasury shares.

6. Non-controlling interest (minority interest).

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 EQUITY
a. Generally, the amount of ordinary shares
repurchased. 1. Share capital.

b. The excess of amounts paid-in over the par or 2. Share premium.

stated value.
3. Retained earnings.
c. A portion of the equity of subsidiaries not owned
4. Accumulated other
by the reporting company.
comprehensive income.
d. The par or stated value of shares issued. It
5. Treasury shares.
includes ordinary shares and preference
shares. 6. Non-controlling interest
(minority interest).
e. The corporation‘s undistributed earnings.

f. The aggregate amount of the other

comprehensive income items.

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 Issuance of Shares

Accounting problems involved in the issuance of shares:

1. Par value shares.

2. No-par shares.

3. Costs of issuing shares.

4. Shares issued in combination with other securities.

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 Issuance of Shares

Par Value Shares

Par value: The stated value on a stock certificate.

Corporations maintain accounts for:

 Preference Shares or Ordinary Shares.
 Share Premium.

Does par value of stock always remain unchanged?

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 Issuance of Shares

Illustration: Video Electronics Corporation is organized with

10,000 ordinary shares authorized with a €6 par value. If Video
Electronics issues 500 shares for cash at €10 per share, it
makes the following entry.

Cash (500 x €10) 5,000

Share Capital—Ordinary (500 x €6) 3,000
Share Premium—Ordinary 2,000

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 Issuance of Shares

No-Par Shares

Reasons for using no-par shares:

 Avoids potential liability in the event of liquidation.
 Avoids confusion over recording par value versus fair
market value.

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 No-Par Shares in Hong Kong

 From March 3, 2014, all shares, whether issued before or after

that date, will lose their par value. This applies to both existing
and new companies incorporated in Hong Kong. This change
is brought about by the new Hong Kong Companies
Ordinance Cap. 622 (“new CO”), which abolishes par value.
 It is considered that retiring the concept of par creates an
environment with greater clarity and simplicity and is more
desirable for the business community generally. Jurisdictions
that have adopted mandatory no-par value shares include
Australia, New Zealand and Singapore.

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 Issuance of No-Par Shares

Illustration: Video Electronics AG is organized with 10,000

ordinary shares authorized without par value. If Video
Electronics issues 500 shares for cash at €10 per share, it
makes the following entry.

Cash 5,000
Share Capital—Ordinary 5,000

Video Electronics issues another 500 shares for €11 per share.
Cash 5,500
Share Capital—Ordinary 5,500

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 Issuance of No-Par Shares

Illustration: Some countries require that no-par shares have a

stated value. If a company issued 1,000 of the shares with a €5
stated value at €15 per share for cash, it makes the following
entry.

Cash 15,000
Share Capital—Ordinary 5,000
Share Premium—Ordinary 10,000

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 Issuance of Shares

Costs of Issuing Stock

Direct costs incurred to sell shares, such as
 underwriting costs,
 accounting and legal fees,
 printing costs, and
 taxes,
should reduce the proceeds received from the sale of
the shares.

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 Issuance of Shares

Illustration: Video Electronics Corporation is organized with

10,000 ordinary shares authorized without par value. If Video
Electronics issues 500 shares for cash at €10 per share, and
incurs underwriting costs of €1,000, it makes the following entry.

Cash (500 x €10 – €1,000) 4,000

Share Capital—Ordinary 4,000

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 Issuance of Shares

Shares Issued with Other Securities

Two methods of allocating proceeds:
 Proportional method.
 Incremental method.

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par
value ordinary shares and 100 shares of $50 par value preference
shares for a lump sum of $13,500. The ordinary shares have a market
value of $20 per share, and the preference shares have a market
value of $90 per share.

Number Amount Total Percent

Ordinary shares 300 x $ 20.00 = $ 6,000 40%
Preference shares 100 x 90.00 9,000 60%
Fair Market Value $ 15,000 100%

Allocation: Ordinary Preference

Issue price $ 13,500 $ 13,500 Proportional
Allocation % 40% 60%
Total $ 5,400 $ 8,100
Method

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par
value ordinary shares and 100 shares of $50 par value preference
shares for a lump sum of $13,500. The ordinary shares have a market
value of $20 per share, and the preference shares have a market
value of $90 per share.

Journal entry (Proportional method):

Cash 13,500
Share Capital—Preference (100 X $50) 5,000
8,100
Share Premium—Preference 3,100
Share Capital—Ordinary (300 X $10) 3,000
5,400
Share Premium—Ordinary 2,400

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par value
ordinary shares and 100 shares of $50 par value preference shares for a
lump sum of $13,500. The ordinary shares have a market value of $20
per share, and the value of preference shares are unknown.

Number Amount Total

Ordinary shares 300 x $ 20.00 = $ 6,000
Preference shares 100 x -
Fair Market Value $ 6,000

Allocation: Ordinary Preference

Issue price $ 13,500 Incremental
Ordinary (6,000) Method
Total $ 6,000 $ 7,500

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par value
ordinary shares and 100 shares of $50 par value preference shares for a
lump sum of $13,500. The ordinary shares have a market value of $20
per share, and the value of preference shares are unknown.

Journal entry (Incremental):

Cash 13,500
Share Capital—Preference (100 X $50) 5,000
7,500
Share Premium—Preference 2,500
Share Capital—Ordinary (300 X $10) 3,000
6,000
Share Premium—Ordinary 3,000

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 CPA Question (Poll)

On July 1, 2019, Nall Co. issued 2,500 shares of its €10 par
ordinary shares and 5,000 shares of its €10 par convertible
preference shares for a lump sum of €125,000. At this date
Nall’s ordinary shares were selling for €24 per share and the
convertible preference shares for €18 per share. The amount
of the proceeds allocated to Nall’s preference shares should be
A. €62,500.
B. €75,000. (18*5000)/(24*2500 + 18*5000)*125,000

C. €90,000.
D. €68,750.

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 Preference Shares
Preference shares: a special class of shares that
possess certain preferences of features not
possessed by ordinary shares.
Features often associated with preference shares.
1. Preference as to dividends.

2. Preference as to assets in the event of liquidation.

3. Convertible into ordinary shares.

4. Non-voting.

The accounting for preference shares at issuance is similar

to that for ordinary shares.
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 PREFERENCE SHARES

Miscellaneous facts about preference shares

 A preference to dividends does not assure the payment of
dividend.
 A company often issues preference shares (instead of
debt) because of a high debt to equity ratio.

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 PREFERENCE SHARES

 Cumulative Preference Shares

 If a corporation fails to pay a dividend in any year, it
must make it up in a later year before paying any
dividends to ordinary shareholders.
 Dividend in arrears: passed dividend that the
corporation fails to declare at the normal date for
dividend action.
 More marketable than non-cumulative preference
shares.

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 PREFERENCE SHARES

 Convertible Preference Shares

 Allow shareholders to convert the preference
shares into ordinary shares at a predetermined
ratio, usually any time after a predetermined
date.

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 Convertible Preference Shares
Illustration:
Imagine you bought 100 shares of convertible preferred stock in
XYZ corporation. The preferred stock cost you $500 per share, so
your total investment is $50,000. The conversion privilege allows
you to convert each share of preferred stock into 50 shares of
common stock.
Your "cost" of converting to common is $10 per share ($500
preferred stock divided by 50 shares of common stock = $10 cost
per share in the event of conversion).
If the common stock is less than $10, your convertible preferred
rights aren't worth much. If the common stock is $10 or more, your
conversion rights can be valuable.
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 Preference Shares

Illustration: Bishop plc issues 10,000 shares of £10 par

value preference shares for £12 cash per share. Bishop
records the issuance as follows:

Cash 120,000
Share Capital—Preference 100,000
Share Premium—Preference 20,000

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 Dual-class Shares

Dual class Shares

 Within ordinary shares, companies might issue different classes
of shares that can differ in voting rights and/or dividend
payments.
 Dual class structure provides a portion of the shareholders the
ability to control majority voting power with a relatively small
percentage of total equity.
 Supporters and Opponents.

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 LEARNING OBJECTIVE 2
Reacquisition of Shares Explain the accounting and
reporting for treasury shares.

Companies purchase their outstanding shares to:

1. Increase earnings per share and return on equity.
2. Provide shares for employee compensation contracts or to
meet potential merger needs.
3. Thwart takeover attempts or to reduce the number of
shareholders.
4. Make a market in the shares.

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 Stock Buybacks: Destroy Capital?

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15-31
 Reacquisition of Shares

Treasury Shares

 After reacquiring shares, a company may either retire

them or hold them in the treasury for reissue. If not
retired, such shares are referred to as treasury shares.

Are Treasury Shares

Assets?

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 Treasury Shares

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 Reacquisition of Shares

Purchase of Treasury Shares

Two acceptable methods:
 Cost method (more widely used).
 Par (stated) value method.

Treasury shares reduce equity.

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 Purchase of Treasury Shares

Illustration: Pacific Company issued 100,000 shares of $1 par

value ordinary shares at a price of $10 per share. In addition, it
has retained earnings of $300,000.

ILLUSTRATION 15.4
Equity with No Treasury Shares

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 Purchase of Treasury Shares

Illustration: Pacific Company issued 100,000 shares of $1

par value ordinary shares at a price of $10 per share. In
addition, it has retained earnings of $300,000.
On January 20, 2019, Pacific acquires 10,000 of its shares at
$11 per share. Pacific records the reacquisition as follows.

Treasury Shares 110,000

Cash 110,000

Reduce Equity

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 Purchase of Treasury Shares

Illustration: The equity section for Pacific after purchase of the

treasury shares.

ILLUSTRATION 15.5
Equity with Treasury Shares

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 Reacquisition of Shares

Sale of Treasury Shares

 Above Cost
 Below Cost

Both increase total assets and equity.

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 Sale of Treasury Shares

Sale of Treasury Shares above Cost. Pacific acquired

10,000 treasury shares at $11 per share. It now sells 1,000
shares at $15 per share on March 10. Pacific records the entry
as follows.

Cash 15,000
Treasury Shares 11,000
Share Premium—Treasury 4,000

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 Sale of Treasury Shares

Sale of Treasury Shares below Cost. Pacific sells an

additional 1,000 treasury shares on March 21 at $8 per share,
it records the sale as follows.

Cash 8,000
Share Premium—Treasury 3,000
Treasury Shares 11,000

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 Sale of Treasury Shares

ILLUSTRATION 15.6
Treasury Share
Transactions in Share
Premium—Treasury
Account

Illustration: Assume that Pacific sells an additional 1,000 shares

at $8 per share on April 10.
Cash 8,000
Share Premium—Treasury 1,000
Retained Earnings 2,000
Treasury Shares 11,000

After eliminating the credit balance in Share Premium-

Treasury, the corporation debits any additional excess of cost
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over selling price to Retained Earnings LO 2
 CPA Question (Poll)
At its date of incorporation, Sauder, Inc. issued 100,000 shares of
its €10 par ordinary shares at €11 per share. During the current
year, Sauder acquired 20,000 ordinary shares at a price of €16
per share and accounted for them by the cost method.
Subsequently, these shares were reissued at a price of €12 per
share. There have been no other issuances or acquisitions of its
own ordinary shares. What effect does the reissuance of the
shares have on the following accounts?

Retained Earnings Share Premium

a. Decrease Decrease
b. No effect Decrease Answer: c
c. Decrease No effect
d. No effect No effect
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 LEARNING OBJECTIVE 3
Dividend Policy Explain the accounting and
reporting issues related to
dividends.

Few companies pay dividends in amounts equal to

their legally available retained earnings. Why?
1. Maintain agreements with creditors.
2. Meet corporation requirements.

3. To finance growth or expansion.

4. To smooth out dividend payments.

5. To build up a cushion against possible losses.

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 Dividend Policy

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 Dividend Policy

Types of Dividends

1. Cash dividends. 3. Liquidating dividends.

2. Property dividends. 4. Share dividends.

All dividends, except for share dividends, reduce the total

equity in the corporation.

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 Dividend Policy

Cash Dividends
 Board of directors vote on the declaration of cash
dividends.
 A declared cash dividend is a liability.

 Companies do not Three dates:

declare or pay cash a. Date of declaration
dividends on treasury b. Date of record
shares.
c. Date of payment

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 Dividend Policy

Illustration: Roadway Freight Corp. on June 10 declared a cash

dividend of 50 cents a share on 1.8 million shares payable July
16 to all shareholders of record June 24.

At date of declaration (June 10)

Retained Earnings 900,000
Dividends Payable 900,000

At date of record (June 24) No entry

At date of payment (July 16)

Dividends Payable 900,000
Cash 900,000

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 CPA Question (Poll)

At December 31, 2018 and 2019, Plank Corp. had outstanding

2,000 shares of €100 par value 8% cumulative preference shares
and 10,000 shares of €10 par value ordinary shares. At
December 31, 2018, dividends in arrears on the preference
shares were €8,000. Cash dividends declared in 2019 totaled
€30,000. What amounts were payable on each class of stock?
Preference Shares Ordinary Shares
a. €16,000 €14,000
b. €22,000 €8,000
Answer: c
c. €24,000 €6,000
d. €30,000 €0
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 Dividend Policy

Property Dividends
 Dividends payable in assets other than cash.
 Restate at fair value the property it will distribute,
recognizing any gain or loss.

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 Dividend Policy

Illustration: Tsen, Ltd. transferred to shareholders some of its

investments (held-for-trading) in securities costing HK$1,250,000
by declaring a property dividend on December 28, 2018, to be
distributed on January 30, 2019, to shareholders of record on
January 15, 2019. At the date of declaration the securities have a
fair value of HK$2,000,000. Tsen makes the following entries.

At date of declaration (December 28, 2018)

Equity Investments 750,000
Unrealized Holding Gain or Loss—Income 750,000
Retained Earnings 2,000,000
Property Dividends Payable 2,000,000

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 Dividend Policy

Illustration: Tsen, Ltd. transferred to shareholders some of its

investments (held-for-trading) in securities costing HK$1,250,000
by declaring a property dividend on December 28, 2018, to be
distributed on January 30, 2019, to shareholders of record on
January 15, 2019. At the date of declaration the securities have a
fair value of HK$2,000,000. Tsen makes the following entries.

At date of distribution (January 30, 2019)

Property Dividends Payable 2,000,000
Equity Investments 2,000,000

What if the fair value of the securities

is no longer 2,000,000 on Jan 30, 2019?
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 CPA Question (Poll)
Farmer Corp. owned 20,000 shares of Eaton Corp. purchased in
2018 for €240,000. On December 15, 2018, Farmer declared a
property dividend of all of its Eaton Corp. shares on the basis of
one share of Eaton for every 10 ordinary shares of Farmer held by
its shareholders. The property dividend was distributed on January
15, 2019. On the declaration date, the aggregate market price of
the Eaton shares held by Farmer was €400,000. The entry to
record the declaration of the dividend would include a debit to
Retained Earnings of
A. €0.
B. €160,000. How about the net effect
on retained earnings?
C. €240,000.
D. €400,000.
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 Share Dividends

Share Dividends
 Issuance by a corporation of its own shares to shareholders
on a pro rata basis, without receiving any consideration.
 Par value, not the fair value, is used to record the share
dividend.
 Share dividend does not affect any asset or liability.
 Journal entry reflects a reclassification of equity.
 Ordinary share dividend distributable reported in the equity
section as an addition to share capital—ordinary.

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 Share Dividends

Illustration: Vine plc has outstanding 100,000 shares of £1 par

value ordinary shares and retained earnings of £50,000. If Vine
declares a 10 percent share dividend, it issues 10,000 additional
shares to current shareholders. If the fair value of the shares at
the time of the share dividend is £8 per share, the entry is:

Date of declaration

Retained Earnings 10,000

Ordinary Share Dividend Distributable 10,000

How will stock price change

after distributing share dividends?
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 Share Dividends

Illustration: Vine plc has outstanding 100,000 shares of £1 par

value ordinary shares and retained earnings of £50,000. If Vine
declares a 10 percent share dividend, it issues 10,000 additional
shares to current shareholders. If the fair value of the shares at
the time of the share dividend is £8 per share, the entry is:

Date of distribution

Ordinary Share Dividend Distributable 10,000

Share Capital—Ordinary 10,000

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 Share Splits

Share Splits
 To reduce the market value of shares.
 No entry recorded for a share split.
 Decrease par value and increased number of
shares.

ILLUSTRATION 15.13
Effects of a Share Split

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 Share Dividends vs. Share Splits

Share Split and Share Dividend Differentiated

A share split differs from a share dividend. How?
 A share split increases the number of shares
outstanding and decreases the par or stated value per
share.
 A share dividend,
► increases the number of shares outstanding.
► does not decrease the par value.
► increases the total par value of outstanding shares.

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 CPA Question (Poll)
On December 31, 2018, the equity section of Arndt, Inc., was as follows:
Share capital—ordinary, par value €10; authorized 30,000 shares; issued and
outstanding 9,000 shares € 90,000
Share premium—ordinary 116,000
Retained earnings 174,000
Total equity €380,000

On March 31, 2019, Arndt declared a 10% share dividend, and accordingly 900
additional shares were issued, when the fair value was €18 per share. For the
three months ended March 31, 2019, Arndt sustained a net loss of €32,000.
The balance of Arndt’s retained earnings as of March 31, 2019, should be
a. €125,800.
b. €133,000.
c. €134,800.
Answer: b
d. €142,000.

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 Ortago S.A.’s €10 par ordinary shares are selling for €110 per
share. Four million shares are currently issued and outstanding.
The board of directors wished to stimulate interest in Ortago S.A
ordinary shares before a forthcoming share issue but does not wish
to distribute cash at this time. The board also believes that too
many adjustments to the equity section, especially retained
earnings, might discourage potential investors. The Board has
considered three options for stimulating interest in the shares:

1. A 20% share dividend.

2. A 100% share dividend.
3. A 2-for-1 share split.

Acting as financial advisor to the board, you have been asked to

report briefly on each option and, considering the board's wishes,
make a recommendation. Discuss the effects of each of the
foregoing options.

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 Option 1:

Retained Earnings (€10 * 800,000) 8,000,000

Share Capital—Ordinary 8,000,000

• This option would increase the shares outstanding by 20

percent;
• Decreased market price;
• However, the reduction in Retained Earnings may hinder
Oregon Inc.’s success with the subsequent share offer –
future dividends are limited to available retained
earnings

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 Option 2:

Retained Earnings (€ 10 * 4,000,000) 40,000,000

Share Capital—Ordinary 40,000,000

• This option would double the shares outstanding

• Decreased market price
• The reduction in Retained Earnings is great:
€ 40,000,000.
 

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 Option 3:

• This option doubles the number of shares issued and

outstanding;
• It cuts the par value per share in half;
• Retained Earnings, Share Capital, Share Premium all
remain unchanged
• Decreased market price

To generate the greatest interest in Ortago S.A. shares

while maintaining the present balances in the equity
section of the statement of financial position, you should
opt for the 2-for-1 share split.

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 Suggested End-of-Chapter Exercises

•P15-5
•P15-7
•P15-8

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