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FINANCIAL ACCOUNTING 2
SHAREHOLDERS’ EQUITY
The primary forms of business organization are sole proprietorship, partnership, and corporation. In terms of aggregate amount of resources controlled, volume of production, and number of people involved, a corporate form is by far the highest in rank. It is the dominant form in the business world today because of the many advantages in its organization, capitalization, and management.
A corporation is defined under the Corporation Code of the Philippines 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. It has a juridical personality, which is separate and distinct from its owners.
The shareholders of a corporation elect the members of the board of directors, who oversee the strategic and long-run planning for the corporation.
Although there may be different kinds of corporation, accounting procedures may not at all vary. The residual interest of owners in the net assets of a corporation is called stockholders’ equity or shareholders’ equity. This is measured by the excess of assets over liabilities.
Equity is defined as the residual interest, and this amount may be sub- classified on the balance sheet. In a corporation, funds contributed by the shareholders, retained earnings, and reserves representing capital maintenance adjustments are shown separately on the balance sheet.
The shareholders’ equity section of the balance sheet should be presented in sufficient details to provide a clear understanding of the capital structure of the enterprise and the sources of capital currently in use. When more than one class of share capital exists, the various classes should be listed separately in the order of their preferences in liquidation.
The following categories normally appear as components of the shareholders’ equity.
- Contributed Capital or Paid-in Capital
- Retained Earnings
- Other Comprehensive Income
- Share Capital Subscription Receivable
- Treasury Shares
Contributed Capital
Contributed Capital otherwise known as Paid-in Capital, represents the amount invested or contributed by owners. This category is composed of share capital and additional paid-in capital. Share capital represents the contribution equal to the par or stated value of the shares purchased by owners; or the total contribution by owners, in case of no par, no stated value share capital. Additional paid-in capital represents contribution in excess of the par or stated value of the share capital. This may arise from various share capital transactions and other transactions with shareholders and may be described appropriately. Additional paid-in capital may arise from issuance of share capital in excess of par, resale or retirement of treasury shares; distribution of share dividends (also called as capitalization or bonus issue), issuance of detachable share purchase warrants, changes in the par value (or stock recapitalization), donation of assets to the corporation, and transactions resulting to corporate readjustment or quasi-reorganization.
Because corporations are characterized by limited liability, the law protects the interest of the corporate creditors by requiring a corporation to maintain in its equity an amount at least equal to its legal capital.
For an enterprise that issues share capital with par value, legal capital represents the par value of all share capital issued and subscribed. Thus, the following ledger balances represent the total legal capital:
- Share capital
- Subscribed share capital
When a corporation issues no par value share capital, its legal capital is the total peso amount of consideration received or receivable on shares issued and subscribed. Thus, the following ledger balances represent the total legal capital:
- Share capital
- Subscribed share capital
Participating preference shares are those that provide for additional dividends to be paid to the holders thereof, proportionate to the ordinary shareholders on the basis of total par value, in excess of a fixed amount or rate.
A convertible preference share entitles the holder to exchange the same to ordinary share, at the option of the shareholder.
A callable preference share is one that gives the issuing corporation the right, but not the obligation, to reacquire and retire the share at a fixed or determinable call price.
A redeemable preference share is one that must be retired or reacquired by the issuing corporation, either at the option of the shareholder, or in most cases, at a certain or determinable date.
The maximum number of shares that the corporation may issue as stated in its articles of incorporation is called authorized shares.
Issued shares represent the number of shares that the corporation has issued to its shareholders as of a specific date. This is indicated by the amount reported in the Share Capital account, expressed in terms of number of shares.
Outstanding shares are the shares of stock that have been issued and are still in the hands of the shareholders as of a specific date.
Treasury shares represent shares that have been issued to shareholders and have been reacquired by the corporation, either by purchase or by donation, but not retired. A treasury share carries no voting or pre-emptive right. There are two methods of accounting for treasury shares, the cost method and the par value method.
Subscribed shares are the shares of stock that will be issued upon completion of an installment contract with an investor. Subscribed shares which are not delinquent shall have all the rights of a shareholder including the right to dividends.
- If the subscription is not on call, Subscription Receivable should be presented as a contra-account to the Subscribed Share Capital.
- If the subscription is on call not longer than one year, Subscription Receivable should be presented in the Current Assets.
- If the subscription is on call longer than one year, Subscription Receivable should be presented in the Non-Current Assets.
When stock subscription is not paid on call date, the stock is said to be delinquent. The unpaid subscription may be sold to the highest bidder. The highest bidder is one who is willing to pay the unpaid subscription, including incremental costs, for the least number of shares.
Retained Earnings
Retained earnings represent the company’s accumulated net income or net loss, including prior period adjustments, appropriation reserves, and reversal of appropriation reserves. Dividends, of any form, are also charged against retained earnings.
The total amount of Retained Earnings may be available for dividends, unless there is a restriction. There may be instances when a corporation may need its resources. Hence, it is not advisable to declare and distribute all of it as dividends. In such case, an appropriation must be set up. Appropriations may be for plant expansion, contingencies, and bond and stock redemption.
When the intent or purpose of the appropriation has been accomplished, it is reverted to the unrestricted portion.
Prior Period Error/Adjustment
Prior period errors are omissions from, and misstatements in, the financial statements for one or more periods arising from failure to use, or misuse, available reliable information. Prior period errors result to either a net understatement or net overstatement of the Retained Earnings account. The adjustment should be taken up net of the related income tax.
