Chapter Three-

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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Preview of the Chapter

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 Corporate Capital

Three primary forms of business organization.

Proprietorship Partnership Corporation

Special characteristics of the corporate form:

1. Influenced by corporate law.
2. Use of the share system.
3. Development of a variety of ownership
interests(preffered vs ordinary shareholders)
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 Commercial code Article 245. Definition of
corporation
 A share company is a company whose capital is fixed in
advance and divided into shares and whose liabilities are
met only by the assets of the company.
 The obligation of the shareholders shall be limited to
making the contribution they pledged to make to the
company.

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 Corporation Formation
 Corporation must submit articles of incorporation to the
appropriate governmental agency for the country in which
incorporation is desired.
 Shares are sold and cash is deposited in a blocked bank
account opened in the name of the company under
formation.
 This cash may be withdrawn from the bank account when
the company is registered in the commercial register and
at least 25% of the capital is paid up
 A company shall obtain legal personality upon registration.
 The minimum number of shareholder is 5(five)
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 Corporate Form
Rights of share holders
In the absence of restrictive provisions, each share carries the
following rights:

1. To share proportionately in profits and losses.

2. To share proportionately in management (the right to

vote for directors).
3. To share proportionately in assets upon liquidation.
4. To share proportionately in any new issues of shares of
the same class—called the preemptive right.

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 Variety of Ownership Interests/ Classes
of shares
Ordinary shares / common stock : represent the residual
corporate interest.
 Bears ultimate risks of loss.
 Receives the benefits of success.
 Not guaranteed dividends nor assets upon dissolution.

Preference shares/ preferred stock : are created by contract,

when shareholders’ sacrifice certain rights in return for other
rights or privileges, usually dividend preference.

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 Components of Equity
Equity is often subclassified on the statement of financial position
into the following categories

1. Share capital
2. Share premium.
3. Retained earnings.

4. Other comprehensive income.

5. Treasury shares.
6. Non-controlling interest (minority interest).

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 Components of Equity

Ordinary Shares
Contributed Account
Capital/paid up Share Premium
capital Account
Preference Shares
Account

Two Primary
Retained Earnings
Sources of
Account
Equity

Less:
Treasury Shares
Account

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 Issuance of Shares

Accounting for the issuance of shares:

1. Par value shares.

2. No-par shares.
3. Shares issued in non-cash transactions.

4. Costs of issuing shares.

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 Issuance of Shares

Par Value Shares

• It’s a value given for one share in the charter( article of
incorporation)
• Used to distinguish between legal capital and premium
capital
• Low par values help companies avoid a contingent
liability( legal capital)
Corporations maintain accounts for:
 Preference Shares or Ordinary Shares/ minimum or legal
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capital LO 1
 Issuance of Shares

No-Par Shares
 Share premium doesn’t exist
 All share capital is legal capital
 Commercial code of Ethiopia requests share
company to specify par value in article of association

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 Issuance of Shares
Illustration: Jacaranda Agri business S.C was formed with 10,000
ordinary/common shares authorized without par value.

If Jacaranda issued 1,000 shares at birr 1,000 each and after a month
issued another 2,000 shares at birr 1,100 each , record the stock
issuance.
Cash 1,000,000
Common stock 1,000,000

Second issuance

Cash 2,200,000
Common stock 2,200,000

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 Issuance of Shares

What if Jacaranda shares have birr 800 par value. What is

the legal capital of the company and what will the entry be to
record the issuance:
Cash 1,000,000
Common Stock 800,000
Share Premium—Common stock 200,000

Cash 2,200,000
Common Stock 1,600,000
Share Premium—Common stock 600,000

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 Issuance of Shares

Shares Issued in Noncash Transactions

The general rule: Companies should record shares issued for
services or property other than cash at the
 fair value of the goods or services received.
 If the fair value of the goods or services cannot be
measured reliably, use the fair value of the shares issued.

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 Shares Issued in Noncash Transactions

Illustration: The following series of transactions illustrates the

procedure for recording the issuance of 10,000 shares of €10
par value ordinary shares for a plot of Land
If the fair value of the land cannot be determined , but we
know the fair value of the shares is €140,000.
Land 140,000
Common Stock 100,000
Share Premium—common stock 40,000

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 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
and share premium
Example: A share company issued 500 ordinary shares,1000birr
par, for 1,200birr each and incurred issuance cost of 40,000 birr
Cash(500*1,200-40,000)…………….560,000
Ordinary stock (500*1000)
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………………………..500,000
 Preference Shares

Features often associated with preference shares.

1. Preference as to dividends.

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

3. Non-voting.

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 Preference Shares

Features of Preference Shares

 Cumulative
A corporation may attach
 Participating whatever preferences or
restrictions, as long as it does
not violate its
country’s incorporation law.

The accounting for preference shares at issuance is similar

to that for ordinary shares.

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 Preference Shares

Illustration: Bishop S.C issues 10,000 shares of £10 par

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

Cash 120,000
Preferred Stock 100,000
Share Premium—Preferred Stock 20,000

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 Reacquisition of Shares/Treasury Shares
Companies may purchase back their outstanding shares to:
1. Increase earnings per share
2. Increase return on equity.
3. Provide shares for employee as compensation( bonus)
4. Issue as a stock dividend
5. Prevent takeover attempts or to reduce the number of
shareholders.
6. Support the market price.
Treasury stock usually does not have:
 Voting, Dividend, preemptive and liquidation rights.

Treasury shares reduce equity( reported as a deduction

from
15-21 shareholders equity)
 Equity Reporting without Treasury Stock
Illustration: Pacific Share 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. But doesn’t have
treasury shares. The equity of the company will be presented as
follows:

Assume , On January 20, 2019, Pacific acquires 10,000 of its

shares at $11 per share. The share company records the re-
acquisition as follows with its balance sheet presentation:
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 Equity reporting with Treasury Stock
Treasury Shares 110,000
Cash 110,000

NB: share capital(common stock) is not reduced directly(still $100,000), but

reduced through treasury stock
 Issued shares and outstanding shares are not necessary the same in
the existence of treasury shares:
 Outstanding shares: are shares currently on the hands of
shareholders
 Issued shares: are both outstanding and treasury shares( outstanding
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shares + treasury shares)
 Sale of Treasury Shares
Treasury Shares can be sold at:
 Above Cost
 Below Cost( as long as its not blow par value)
 Both increase total assets and equity.
 Treasury shares decreases( credited ) by purchase cost
irrespective of selling price
 Ifsold for a price above cost, share premium –treasury stock
is credited
 If sold for a price below cost, share premium –treasury
stock is debited if it has balance, otherwise retained earning
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Sale of Treasury Shares
1. Sale of Treasury Shares above Cost(gain) . Pacific
share company now re-sold 1,000 of the treasury
shares at $15 per share on March 10. Pacific records
Cash
the 15,000
entry as follows.
Treasury Shares 11,000
Share Premium—Treasury 4,000

What if it sold the shares for $ 9 each instead of $15?

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 Sale of Treasury Shares

2. Sale of Treasury Shares below Cost(loss) . Pacific

sold 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

3. Sale of Treasury Shares below Cost(loss) : Assume that

Pacific further sold 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

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Retiring Treasury Shares
Decision results in
 Cancellation of the treasury shares/ Ordinary shares are
directly reduced(debited)
 Treasury shares account will be de-recognized from equity
component
 A reduction
Common in the number of shares of issued shares.
stock xxx
Share
 But Premium—Common
total equity will not stock
change xxx
Treasury Shares xxx
Retired treasury shares have the status of authorized and
Example: Assume pacific share company’s board decided to
unissued
retire ashares
10,000and the entry
treasury to record
shares retirement
it purchased willre-selling
without be as
follows:
any of it. The entry will be :
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 Retiring Treasury Shares
To record treasury shares( purchase back )
Treasury Shares 110,000
Cash 110,000

To record retirement of treasury shares

Ordinary Shares (10,000*$1) 10,000
Share premium-ordinary 100,000
Treasury shares 110,000

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 Dividend

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.

 Not legally required
Companies do not declare or pay cash dividends on
treasury shares.
Three dates:
a. Date of declaration
b. Date of record
c. Date of payment
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Example
Illustration: Roadway Freight S.C 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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 Property/ non cash asset Dividends
 Is distributions of non-cash assets as dividend
 Adjust non cash assets at fair value .
 Recognize gain or loss for difference between book value
and fair value.
Example: Assume Volkswagen S.C decided to distribute the
Electric car, new 2022 model to its share holders as a property
dividend on December 28, 2022 to be distributed on January 30,
2023. The manufacturing cost of those cars is $1,250,000 and
they could be sold in the market for $2,000,000. Record the
entry on declaration and payment date

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 Property/ non cash asset Dividends
At date of declaration (December 28, 2022)

Finished Goods Inventory 750,000

Gross profit - income 750,000
Retained Earnings 2,000,000
Property Dividends Payable 2,000,000

At date of distribution (January 30, 2023)

Property Dividends Payable 2,000,000

Finished Goods Inventory 2,000,000

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 Liquidating Dividends

Liquidating Dividends
Is usually a cash dividend
Is a dividend paid from paid up capital(share premium)
of the corporation, not from the earning
This dividend reduces amounts paid-in by shareholders.
( share premium)

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 Liquidating Dividends

Illustration: Mercy Corporation issued a “dividend” to its

ordinary shareholders of $1,200,000. The company has ordinary
shares of $ 5,000,000, share premium - ordinary of $2,000,000
and retained earning of $ 900,000. The company will record the
dividend as follows.
Date of declaration
Retained Earnings 900,000
Share Premium—Ordinary 300,000
Dividends Payable 1,200,000
Date of payment

Dividends Payable 1,200,000

Cash 1,200,000
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 Share Dividends
 Issuance by a corporation of its own shares to
shareholders on a pro rata basis, without receiving any
consideration.
 Reasons why corporations issue stock dividends:
1. Satisfy stockholders’ dividend expectations without
spending cash
2. Increase marketability of corporation’s stock
 Journal entry reflects a reclassification of equity. i.e
 increases the number of shares outstanding.
 does not decrease the par value.
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
 Share Dividends-Example
Example: Coca cola S.C declared and distributes a 20%
stock dividend on 5 million outstanding common shares. Par
value is $1 and market value is $20. Retained earning had a
balance of $27,000,000. The required journal entry would be:
Share Dividend= 5,000,000 shares × 20 % = 1,000,000 shares issued × $20 =
$20,000,000

Retained earnings ........................ 20,000,000

ordinary shares– distributable dividend…. 20,000,000

To record declaration

Common stock – distributable dividend...... 20,000,000

Ordinary shares …………………………. 1,000,000
Share premium_ ordinary shares 19,000,000
To record payment( issuance of stock)

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 Effects of Stock Dividends on Equity

Before After
Dividend Change Dividend
Stockholders’ equity
$ $6,000,0
Common shares, $1 par $5,000,000 1,000,000 00
Share premium-common 19,000,00 19,000,0
shares 0 00
-
20,000,00 7,000,00
Retained earnings 27,000,000 0 0
Total stockholders’ $32,000,
equity $32,000,000 $0 000
+1,000,00 6,000,00
Outstanding
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shares 5,000,000 0 0
 Share Splits
 Issuance of additional shares to stockholders according to
their percentage ownership without any receipt of cash
 Made to reduce the market value of shares( to make it
affordable)
 Share splits decrease the par value per share and the
number of shares outstanding
 but the total par value( legal capital/ shares outstanding
times par value) is unchanged
 No entry recorded for a share split.

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Share Dividends vs. Share Splits
A share split differs from a share dividend. How?
 A share split
 Increases the number of shares outstanding and
decreases the par per share.
 Does not change any component of equity except,
number of shares outstanding and par value
 A share dividend,
► increases the number of shares outstanding.
► does not decrease the par value.
► Increases paid up capital and decreases retained
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earning
Presentation of Equity

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 The End
With Sincere Thanks

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