CHAPTER 21

SHAREHOLDERS' EQUITY
Treasury shares, rights issue, share split
TECHNICAL KNOWLEDGE
To know the recognition and measurement of treasury shares.
To understand the legal limitation in the acquisition of treasury shares.
To identify the typical recapitalizations.
To understand the recognition of rights issue.
To measure the issuance of preference shares with share warrants.

TREASURY SHARES
Treasury shares are an entity's own shares that have been issued and then reacquired but not
canceled.
Three requisites to qualify as treasury shares:
a. The shares must be the entity's own shares. The acquisition of shares of another entity is
not treasury but an investment.
b. The shares must have been issued originally. This requisite distinguishes treasury shares
from unissued shares.
Treasury shares can be legally reissued at a discount without any discount liability while
unissued shares must be issued at least at par or stated value.
In other respects, treasury shares and unissued shares are the same. Both are equity items rather
than assets.
c. The shares are reacquired but not canceled.
Legal limitation on treasury shares
The Revised Corporation Code provides that no corporation shall redeem, repurchase, or
reacquire its own shares, of whatever class, unless it has adequate amount of unrestricted
retained earnings to support the cost of said shares.
Thus, the corporation can acquire treasury shares only to the extent of retained earnings balance.
If the corporation were allowed to acquire treasury shares when it has no retained earnings
balance or when it has a deficit, it would be tantamount to indirectly returning capital to
shareholders, which is a violation of the trust fund doctrine.
What is prohibited to be done directly cannot be done by indirection
Therefore, in order to preserve the legal capital, the retained earnings must be appropriated to
the extent of the cost of treasury shares, and the same must not be declared as dividend until the
treasury shares are subsequently reissued.

Accounting for treasury shares

The cost method is used in accounting for treasury shares. The reason is the legal limitation on
acquisition of treasury shares.
Treasury shares shall be recorded at cost, regardless of whether the shares are acquired below or
above the stated value.
If the treasury shares are acquired for cash, the cost is equal to the cash payment.
If treasury shares are acquired for noncash consideration, PAS 32 does not provide explicit
guidance.
However, PAS 32, paragraph 33, provides that no gain or loss shall be recognized on the
purchase, sale, issue or cancelation of an entity's equity instrument.
Accordingly, if the treasury shares are acquired for noncash consideration, the cost is usually
measured by the carrying amount of the noncash asset surrendered.
Illustration
An entity acquired 2,000 shares with par of P100 at P150 per share.
Treasury shares 300,000
Cash 300,000
The treasury shares are initially recorded at cost of acquisition
Subsequently, the treasury shares may be reissued or sold at cost, more than cost or below cost.

Reissuance at cost
The treasury shares are subsequently reissued at P150 per share.
Cash 300,000
Treasury shares 300,000

Reissuance at more than cost

The treasury shares are subsequently reissued at P200 per share.
The excess of the reissue price over the cost is treated as share premium
 Cash 400,000
Treasury shares 300,000
Share premium - treasury share 100,000
As stated earlier, no gain or loss shall be recognized on the purchase, sale, issue or cancelation of
an entity's equity instrument.
Thus, gain from sale of treasury shares shall not be credited to income but recognized directly in
equity as share premium.
Reissuance at below cost
The treasury shares are subsequently reissued at P100 per share.
The excess of the cost over the reissue price is charged to the following in the order of priority:
a. Share premium from treasury shares of the same class
b. Retained earnings
In other words, the “loss" on the sale of treasury shares is debited to share premium from
treasury shares of the same class, if any, and when this balance is exhausted, it is charged to
retained earnings.
If there are no previous transactions involving treasury shares, the journal entry is:
Cash 200,000
Retained earnings 100,000
Treasury shares 300,000

Another illustration
Ordinary share capital, 10,000 shares, P100 par 1,000,000
Share premium - original issuance 200,000
Share premium - treasury shares 20,000
Retained earnings 500,000
Treasury shares, 2,000 shares at cost 300,000

Subsequently, the treasury shares are reissued at P100 per share.

Cash (2,000 x 100) 200,000
Share premium – TS 20,000
 Retained earnings 80,000
Treasury shares 300,000

Observe that the share premium from original issuance is not touched.

Par value or stated value method

The par value or stated value method is the other method of accounting for treasury shares. It is
also known as retirement method.
As the title suggests, the treasury shares account is debited at par value or stated value.
For example, if 2,000 shares with par value of P100 are acquired for a total consideration of
P150,000, the journal entry is:
Treasury shares, at par 200,000
Cash 150,000
Share premium - treasury shares 50,000
The cost method is the acceptable method in accounting for treasury shares.
Thus, the par value method is not discussed exhaustively.
The par value or stated value method is not an acceptable approach because of the legal
requirement that "retained earnings must be appropriated to the extent of the cost of treasury
shares."

Retirement of treasury shares

If treasury shares are subsequently retired, the share capital account is debited at par value or
stated value and the treasury shares account is credited at cost.
If the retirement results in a gain, meaning the par value exceeds the cost of treasury shares, such
gain is credited to share premium from treasury shares.
For example, if 1,000 ordinary shares with par of P100 are held as treasury at a cost of P80,000,
and subsequently retired, the journal entry is:
Ordinary share capital 100,000
Treasury shares 80,000
Share premium - treasury shares 20,000
If the retirement results in a loss, meaning, the cost of the treasury shares exceeds the par value,
such loss is debited to the following in the order of priority:
a. Share premium from original issuance
b. Share premium from treasury shares
c. Retained earnings

Illustration
Ordinary share capital, 50,000 shares, P100 par 5,000,000
Share premium - original issuance 500,000
Share premium - treasury shares 100,000
Retained earnings 1,000,000
Treasury shares, 5,000 shares at cost 750,000
The subsequent retirement of the treasury shares is recorded as follows:
Ordinary share capital (5,000 x 100) 500,000
Share premium – issuance 50,000
Share premium - treasury shares 100,000
Retained earnings 100,000
Treasury shares 750,000
Note that the share premium from original issuance is canceled on a prorata basis in the absence
of specific amount identified with the treasury shares.

Disclosure of treasury shares

The disclosure relating to treasury shares shall include the following:
a. The number of shares held in the treasury.
b. The restriction on the availability of retained earning, for distribution of dividends equal to the
cost of treasury shares.
PAS 32, paragraph 33, provides that if an entity reacquires its own equity instruments, the
treasury shares shall be deducted from equity.
Simply stated, the cost of treasury shares shall be deducted from total shareholders' equity.
Under Application Guidance 36 of PAS 32, an entity's own equity instruments are not
recognized as financial asset regardless of the reason for which the equity shares are reacquired.

Presentation of treasury shares

Ordinary share capital, 50,000 shares, P100 par 5,000,000
Share premium 500,000
Retained earnings (of which P600,000 is
appropriated for the cost of treasury shares) 2,000,000
Treasury shares, 5,000 shares at cost (600,000)
Total shareholders' equity 6,900,000

Donated shares
Donated shares refer to shares received by the entity from the shareholders by way of donation.
Donated shares are actually treasury shares and may therefore be reissued at any price without
any discount liability.
Donated shares are secured without cost and consequently, the entity's assets, liabilities and
shareholders' equity are not affected but the number of outstanding shares is reduced.
However, the reissue or resale of donated shares increases assets and donated capital or share
premium.

Illustration
Shareholders donated to the entity an aggregate of 10,000 ordinary shares of their shareholdings
with par of P100. The receipt of the donated shares by the entity is simply recorded by means of
a memorandum entry.
"Received from shareholders as donation 10,000 ordinary shares with P100 par value.”
The 10,000 donated shares are subsequently sold for P150 per share.
Cash 1,500,000
Donated capital 1,500,000
If the donated shares are retired or canceled prior to reissuance, the journal entry is:
 Ordinary share capital (10,000 x 100 par) 1,000,000
Donated capital 1,000,000
The donated capital is part of share premium.

Treasury share subterfuge

Treasury share subterfuge occurs when excessive shares are issued for a property with the
understanding that the shareholders shall subsequently donate a portion of their shares.
The donated shares may then be reissued at a discount without any liability on the part of the
shareholder.
In this case, the resale or reissue of the treasury donated shares is not credited entirely to donated
capital.
The sale price shall be used in correcting the overvalued asset and share capital.
For example, an entity issued 10,000 ordinary shares of P100 par value for land with a legally
determined fair value of P800,000 only.
Land 1,000,000
Ordinary share capital 1,000,000

Actually, the transaction creates a "water" in the ordinary share capital because the land is
overvalued to the extent of P200,000 with a consequent overstatement of shareholders equity.
If subsequently 3,000 shares are donated to the corporation by the shareholders and the same
shares are reissued at P90 per share, the journal entry should be:
Cash 270,000
Land 200,000
Donated capital 70,000

The proceeds from the reissue of the donated treasury shares are not entirely credited to donated
capital but a portion is used to correct the overvaluation of the land.

Donation of capital
Contributions, including shares of an entity, received from shareholders shall be recorded at fair
value with the credit going to donated capital.
Entities sometimes receive from nonshareholders gifts or grants of funds or other assets that are
restricted for property and equipment additions.
Capital gifts or grants shall be recorded at fair value when received or receivable.
Such capital gifts or grants from nonshareholders are generally subsidies and credited to income.
In the rare case where such items are not subsidies, the offsetting credit shall be a liability
account until the restrictions are met.
At that time when the restrictions are met, the capital gifts or grants are transferred to income.

Assessments on shareholders
Assessment may be levied on shareholders when shares are originally issued at discount or when
the corporation is in dire need of financial assistance.
When shares are originally issued at a discount, the discount is actually a receivable from the
shareholder.
For example, if there is a discount on share capital of P100,000 and the same is charged to the
shareholder by virtue of an assessment made by the board of directors, the journal entry is:
Cash or share assessment receivable 100,000
Discount on share capital 100,000

When the corporation is in dire need of financial assistance, the shareholders can vote to assess
themselves a certain amount per share owned.
For example, if the corporation has 100,000 shares issued and outstanding and the shareholders
are assessed P50 per share, the journal entry is:
Cash or share assessment receivable 5,000,000
Share premium – assessments 5,000,000

RECAPITALIZATION
Recapitalization occurs when there is a change in the capital structure of the entity. The old
shares are canceled and new shares are issued.
Typical recapitalizations
a. Change from par to no-par
b. Change from no-par to par
c. Reduction of par value
d. Reduction of stated value
e. Split up
f. Split down

Change from par to no-par

Ordinary share capital, P100 par, 50,000 shares 5,000,000
Share premium 500,000
Retained earnings 2,500,000

Case 1
All the 50,000 shares are called in for cancelation. Instead, 50,000 no-par shares with stated
value of P50 are issued.
Ordinary share capital 5,000,000
Share premium 500,000
Ordinary share capital (50,000 x 50) 2,500,000
Share premium – recapitalization 3,000,000

Case 2
All the 50,000 shares are called in for cancelation. Instead. 50,000 no-par shares with stated
value of P150 per share are issued.
Ordinary share capital 5,000,000
Share premium 500,000
Retained earnings 2,000,000
Ordinary share capital (50,000 x 150) 7,500,000

Note that if the stated value of the new share is more than the original issue price of the par value
share, the difference is charged to retained earnings because in this case, there is capitalization of
the retained earnings.
Changes in the par value of share capital shall be charged or credited to share premium.
If increases in share capital exceed share premium, the excess is charged to retained earnings.

Change from no par to par value share

Ordinary share capital, no-par P100 stated value,
50,000 shares 5,000,000
Retained earnings 2,500,000

Case 1
All the 50,000 shares are called in for cancelation. Instead, 50,000 shares of P50 par value are
issued.
Ordinary share capital 5,000,000
Ordinary share capital (50,000 x 50) 2,500,000
Share premium -recapitalization 2,500,000

Case 2
All the 50,000 shares are called in for cancelation. Instead, 50,000 shares of P150 par value are
issued.
Ordinary share capital 5,000,000
Retained earnings 2,500,000
Ordinary share capital (50,000 x 150) 7,500,000

Reduction of par value

Ordinary share capital, 50,000 shares, P100 par 5,000,000
Share premium 500,000
Retained earnings 2,000,000

A recapitalization is effected whereby the par value of P100 is reduced to P80 per share.

Journal entry
 Ordinary share capital (50,000 x 20) 1,000,000
Share premium – recapitalization 1,000,000

Reduction of stated value

Ordinary share capital, 50,000 shares, P100 stated value 5,000,00
Retained earnings 2,000,000
A recapitalization is effected whereby the stated value of P100 is reduced to P80.
Ordinary share capital (50,000 x 20) 1,000,000
Share premium – recapitalization 1,000,000
Share split
Share split may be in the form of:
a. Split up or share split proper
b. Split down or reverse share split
Split up
Split up is a transaction whereby the original shares are called in for cancelation and replaced by
a larger number accompanied by a reduction in the par value or stated value.
This action is prompted mainly by a desire to increase the number of outstanding shares for the
purpose of effecting a reduction in unit market price.
For example, an entity has 10,000 shares issued and outstanding, with P100 par value. If the
shares are split up 5 to 1, the new capitalization would be 50,000 shares with P20 par value.
Note that before and after the share split, the share capital remains the same.
In order to be properly called a share split, there must not be any change in the amount of share
capital of the entity.
There is only a change in the number of shares and the par value or stated value.

Memorandum entry
No formal entry is necessary to record share split.
It is sufficient that a memorandum is made for the number of new shares issued in exchange for
the old shares plus an indication of the new par value or stated value, as follows:
"Issued 50,000 new shares with par value of P20, as a result of 5-for-1 split of 10,000 old shares
with par value of P100."
Split down
Split down is the reverse of split up. It is a transaction whereby the original shares are canceled
and replaced by a smaller number accompanied by an increase in the par value or stated value.
For example, an entity has 10,000 shares issued and outstanding, with P100 par value. If the
shares are split down 5 to 1, the new capitalization would be 2,000 shares with P500 par value.
The share capital is P1,000,000 before the split (10,000 x P100), and also P1,000,000 after the
split (2,000 x P500).
The number of shares has decreased to 2,000 (10,000/5) and par value has increased to P500
(P100 x 5).

RIGHTS ISSUE
Rights issue is granted to existing shareholders to enable them to acquire new shares at a
specified price during a specified period.
The Philippine term for rights issue is stock right.
Share warrants represent the certificate or instrument evidencing ownership over the rights
issue.
Whenever the share capital of a corporation is increased and new shares are issued, the new issue
must be offered first to the existing shareholders in proportion to their shareholdings before
subscriptions are received from the general public
This is the legal right of shareholders which is called the right of preemption.
In the accounting parlance, this is called stock right or right issue.
The share warrants evidencing the rights issue state the number of shares the holder may
purchase as well as the exercise price.
Normally, the exercise price is less than the current market value of such shares.
Issuance of rights
No entry is required when share warrants are issued to existing shareholders because these
warrants are issued usually without consideration.
The entity only needs to make a memorandum entry to indicate the number of rights issued to
shareholders and the number of shares that can be purchased through the exercise of the rights.
Expiration of rights
Only a memorandum entry is required for the expiration of rights.

Exercise of rights
If the rights are exercised, a memorandum is made for the decrease in the number of shares
claimable through the exercise of the rights.
The sale of shares through the exercise of the rights is then recorded normally.
For example, if cash received, P1,000,000, is equal to the par value of the share capital, the
journal entry is:
Cash 1,000,000
Share capital 1,000,000

If cash received, P1,200,000, is more than the par value of P1,000,000, the journal entry is:
Cash 1,200,000
Share capital 1,000,000
Share premium 200,000

Preference share issued with share warrants

When issuing different types of securities, such as bonds and preference share, warrants may be
included in the issuance as a "sweetener" to make the securities more attractive to the prospective
investors.
When share warrants are issued together with preference share, there is actually a sale of two
securities – the preference share and the share warrants.
Thus, the consideration received shall be allocated between the preference share and the warrants
on the basis of their market value.
Illustration
An entity issued 20,000 preference shares of P100 par value for P3,250,000 with 20,000 warrants
to acquire 10,000, P50 par value ordinary shares at P60 per share. On the date of the issuance,
the market values are:
Preference share ex-warrant 120
Warrant 10
Allocation of issue price
Market Value Fraction Allocated issue price
Preference share (20,000 x 120) 2,400,000 24/26 3,000,000
Warrants (20,000 x 10) 200,000 2/26 250,000
2,600,000 3,250,000
The fractions are developed from the market value and multiplied by P3,250,000 to arrive at the
allocated price.
Accordingly, the journal entry to record the issuance of the preference shares and warrants is:
Cash 3,250,000
Preference share capital (20,000 x 100) 2,000,000
Share premium – PS 1,000,000
Share warrants outstanding 250,000

The share warrants outstanding account is reported as part of share premium.

If subsequently, all 20,000 warrants are exercised requiring the issuance of 10,000 ordinary
shares at P60 per share, the journal entry is:
Cash (10,000 x 60) 600,000
Share warrants outstanding 250,000
Ordinary share capital (10,000 x 50) 500,000
Share premium 350,000
If for any reason, the warrants are not exercised, the share warrants outstanding account is
simply closed and credited to share premium.
Query
If in the given illustration, only the preference share has a known market value of P120 and the
warrant has no known market value, how is the sale price of P3,250,000 allocated?
The procedure is simply to allocate to the security with a known market value an amount equal
to its market value, and the balance is allocated to the other security.
Preference share (20,000 x 120) 2,400,000
Warrants (3,250,000 - 2,400,000) 850,000
3,250,000
 Cash 3,250,000
Preference share capital 2,000,000
Share premium – PS 400,000
Share warrants outstanding 850,000

Another illustration
Preference shares, 20,000, with par value of P100, are issued for P3,250,000, together with
20,000 warrants to acquire 20,000, P50 par value ordinary shares at P60 per share.
The preference share ex-warrant and the warrant have no market value but the ordinary share
has a market value of P100.
In this case, the basis for allocation would be the market value of the ordinary share.
Market value of ordinary share 100
Less: Option price or exercise price 60
Intrinsic value of warrant 40
Multiply by number of ordinary shares under the warrants_ 20,000
Total value of share warrants 800,000
Sale price 3,250,000
Less: Value of share warrants 800,000
Value assigned to preference share 2,450,000

Cash 3,250,000
Preference share capital 2,000,000
Share premium – PS 450,000
Share warrants outstanding 800,000