1. SHAREHOLDERS’ EQUITY Chapter 18 Chapter 18: Shareholders’ Equity
Shareholders’ equity represents the owners’ residual claim on the assets of the corporation. Chapter 18 distinguishes between the two basic sources of shareholders’ equity: (1) invested capital and (2) earned capital. The chapter focuses on the expansion of corporate capital through the issuance of shares and the contraction caused by the retirement of shares or the purchase of treasury shares and concludes with a discussion of cash dividends, property dividends, onus issues of shares, and share splits.
© 2013 The McGraw-Hill Companies, Inc.

2. The Nature of Shareholders’ Equity
Assets – Liabilities = Shareholders’ Equity
Net Assets
Amounts invested by shareholders
Sources of Shareholders’ Equity
Amounts earned by corporation
Part I.
Shareholders’ equity accounts represent the ownership interests of the shareholders in a corporation. From the statement of financial position, total shareholders’ equity equals total assets minus total liabilities. Another way to think about shareholders’ equity is that it represents the portion of a corporation’s assets that have been financed by the owners as opposed to that portion that has been financed by creditors.
Part II.
Corporations have two primary sources of equity: amounts invested by shareholders and amounts earned by the corporation.
Issued capital represents amounts that shareholders have invested by buying shares from the company. The retained earnings account reports the cumulative amount of net income the corporation has earned since its organization less the cumulative amount of dividends declared since organization. This is the portion of the net income that has been reinvested in the business rather than distributed to the owners in dividends. Reserves include all other changes in equity except those resulting from investments by owners and distributions to owners.
Shareholders’ Equity
Other gains and losses not included in net income
Issued Capital
Retained Earnings
Reserves

3. Financial Reporting Overview
Here is a typical shareholders’ equity section of a statement of financial position. Notice that it reports both ordinary and preference shares at par value, additional issued capital for both ordinary and preference shares, retained earnings, examples of reserves, and treasury shares.

4. Reserves or Accumulated Other Comprehensive Income
Reserves or Accumulated other comprehensive income include the following types of gains and losses that traditionally have been excluded from net income.
Gains (losses) from foreign currency translation.
Gains from revaluation of PPE
Reserves or accumulated other comprehensive income is the total change in equity excluding transactions with owners. Typical transactions with owners are dividends and the sale or repurchase of shares.
Comprehensive income starts with net income and adds or subtracts certain unrealized gains and losses that are not reported on the income statement. Comprehensive income includes the following types of gains and losses that traditionally have been excluded from net income:
1. Gains from revaluation of property, plant, and equipment measured using the revaluation model.
2. Net unrealized gains (losses) on available-for-sale investments.
3. Deferred gains (losses) on derivatives.
4. Gains (losses) from foreign currency translation.
5. Gains (losses) from and amendments to postretirement benefit plans.
Net unrealized gains (losses) on available-for-sale instruments
Deferred gains (losses) on derivatives
Gains (losses) from amendments to postretirement benefit plans

5. Presentation of Comprehensive Income
Comprehensive income is reported periodically as it is created.
The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the statement of financial position, under U.S. GAAP, but not under IFRS.
There are 2 options for reporting comprehensive income created during the reporting period.
Comprehensive income is reported periodically as it is created.
There are 2 options for reporting comprehensive income created during the reporting period.
An expanded version of income statement
A separate statement immediately following the income statement
The accumulated amount of comprehensive income is reported as a separate item of shareholders’ equity in the statement of financial position, under U.S. GAAP, but not under IFRS.
An expanded version of income statement
A separate statement immediately following the income statement

6. U.S. GAAP vs. IFRS Comprehensive Income
Single statement of comprehensive income.
Two statements: a separate income statement and a statement of comprehensive income.
Same
Under both IFRS (IAS No. 1, “Presentation of Financial Statements”) and U.S. GAAP, companies can choose to report revenue, expense, and components of other comprehensive income in a single statement of comprehensive income or in two separate, but consecutive statements: an “income statement” and a “statement of comprehensive income”
Prior to June 2011, U.S. GAAP allowed a third presentation option which is to report the items in the statement of changes in shareholders’ equity.
The rationale behind the decision under IFRS and current U.S. GAAP not to allow the third presentation option is to clearly segregate changes in equity arising from transactions with owners in their capacity as owners (statement of changes in shareholders’ equity) from non-owner changes in equity (statement of comprehensive income).

7. The Corporate Organization
Advantages of a corporation
Continuous Existence
Easy ownership transfer
Limited liability
Easy to raise capital
Disadvantages of a corporation
Double taxation
Government regulation
The corporate form of organization has several advantages. The major advantage is the ease of raising large amounts of money because both large and small investors can participate in corporate ownership. In addition, corporate owners can transfer ownership rights very easily. shareholders are generally free to buy and sell ordinary shares to others without permission from the corporation. Organized exchanges, such as the New York Share Exchange, maintain markets in which shares in thousands of companies are bought and sold each business day. shareholders’ losses are limited to the amount invested in the corporation. Corporate creditors cannot make claims on the personal assets of shareholders to satisfy corporate debt. Corporations are a separate legal entity that can enter into contracts and sue and be sued. The corporation continues in existence even when ownership changes.
Corporations also have some disadvantages. Corporations pay taxes on their earnings and then if they distribute a dividend to shareholders, the shareholders pay taxes on the dividends received. This is sometimes referred to as double taxation. Corporations are subject to many laws and regulations Large, publicly traded corporations are much more heavily regulated than smaller closely held corporations. They are subject to the provisions of the Securities and Exchange Commission Acts of 1933 and 1934, the Sarbanes-Oxley Act of 2002, and various exchange listing requirements.

8. Types of Corporations
Not-for-profit corporations include hospitals, charities, and government agencies such as FDIC.
Publicly-held corporations whose shares are widely owned by the general public.
There are two basic types of corporations:
 not-for-profit corporations include hospitals, charities and government agencies such as Federal Deposit Insurance Corporation.
 for-profit corporations that may be either: a. publicly-held corporations whose shares are widely owned by the general public, or
b. privately-held corporations whose shares are owned by only a few individuals.
Our primary focus in this chapter is on corporations formed for the purpose of generating profits.
Privately-held corporations whose shares are owned by only a few individuals.

9. Double taxation avoided.
Hybrid Organizations
Double taxation avoided.
S Corporation (in the United States)
Limited liability protection of a corporation.
Maximum number of owners.
Limited liability company
All owners may be involved in management without losing limited liability protection.
No limit on number of owners.
Limited liability partnership
Owners are liable for their own actions but not entirely liable for actions of other partners.
In the United States, corporation can elect to comply with specific tax rules and be designated an S corporation. Owners of S corporations have limited liability, but income and expenses are passed through to the owners, thereby avoiding double taxation. The number of owners of an S corporation is limited by law.
Owners of a limited liability company are not liable for the debts of the business except to the extent of their investment. All owners can be involved in the management of the company without losing their limited liability. Income and expenses are passed through to the owners so double taxation is avoided. Unlike an S corporation, there are no limits to the number of owners of a limited liability company.
A limited liability partnership is similar to a limited liability company except it doesn’t provide all of the liability protection. Owners are liable for their own actions but not entirely liable for the actions of other owners.

10. Laws and Regulations on Shareholders’ Equity Transactions
Corporations are formed in accordance with the corporation laws and regulations of the individual country or state in which the company is incorporated.
Laws are not uniform across countries or states
In the United States, the Model Business Corporation Act is designed to guide the states in the development of their corporation statutes
Corporations are formed in accordance with the corporation laws and regulations of the individual country or state in which the company is incorporated. These laws are not uniform across countries or states. For example, in the United States, state laws are not uniform but share many similarities, thanks to the widespread adoption of the Model Business Corporation Act which is designed to guide the states in the development of their corporation statutes. This Act presently serves as the model for the majority of states in the U.S.
The laws regarding the nature of shares that can be authorized, the issuance and repurchase of those shares, and conditions for distributions to shareholders obviously influence the actions of corporations. Naturally, differences among country or state laws affect how we account for many of the shareholders’ equity transactions.

11. Fundamental Share Rights
Preemptive right to maintain percentage ownership.
Right to vote.
In addition to the right to buy and sells shares, shareholders have the right to vote at the annual meeting of shareholders. Besides electing members of the board of directors, shareholders often vote on other issues of importance to the operations of the company. Shareholders receive dividends declared by the board of directors. In the event of liquidation, they share equally in any remaining assets after creditors are paid. Shareholders may also have the preemptive right to maintain their percentage ownership when new shares are issued.
Right to share in profits when
dividends are declared.
Right to share in distribution of assets if company is liquidated.

12. Share Capital Legal capital is . . .
Par value share
Dollar amount per share is stated in the corporate charter.
Par value has no relationship to market value.
No-par share
Dollar amount per share is not designated in corporate charter.
Corporations can assign a stated value per share (treated like par value).
Legal capital is . . .
The portion of shareholders’ equity that must be contributed to the firm when share is issued.
The amount of capital, required by law, that must remain invested in the business.
Refers to par value, stated value, or full amount paid for no-par share.
Ordinary share normally has a par value which is usually a very small amount, typically less than one dollar per share. In countries that require a par value per share, the par value is also the legal capital that must remain invested in the business. Par value is an arbitrary amount assigned to each share in the corporate charter, and it is not related in any manner to market value, which is the selling price of a share.
In addition to par value share, some countries permit no-par value ordinary shares. Some countries permit no-par, stated value ordinary shares. In those countries, the stated value is treated just like the par value.
In countries that require a par value or stated value per share, the par value or stated capital is also the legal capital. Legal capital is an outdated concept that refers to the:
portion of shareholders’ equity that must be contributed to the firm when share is issued.
amount of capital, required by state law, that must remain invested in the business.

13. Share Capital Preference shares
Ordinary Share is the basic voting share of the corporation. It ranks after preference shares for dividend and liquidation distribution. Dividends are determined by the board of directors.
Dividend and liquidation preference over ordinary share.
Generally does not have voting rights.
Usually has a par or stated value.
May be convertible, callable, and/or redeemable.
Preference
shares
There are two basic types of share capital: ordinary share and preference share. Ordinary share is the basic voting share of the corporation. It represents the residual claim on assets in liquidation. Dividends paid must first satisfy preference share agreements before any distribution can be made to ordinary shareholders.
Preference share is a separate class of share that typically has priority over ordinary share in dividend distributions and distribution of assets in a liquidation. It normally does not have voting rights and is often callable by the corporation at a stated value. Some preference share issues have an additional preference to be converted into ordinary shares at the shareholder’s choice.

14. Preference Shares
Are usually stated as a percentage of the par or stated value.
May be cumulative or noncumulative.
May be partially participating, fully participating, or nonparticipating.
Preference share usually has a stated dividend that is expressed as a percentage of its par value. Cumulative preference share has the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to ordinary shareholders.
Noncumulative preference share has no rights to prior periods’ dividends if they were not declared in those prior periods. Most preference shares are cumulative.
Preference shares may also participate in dividends beyond the stated amount. Partially participating preference shares have a limit on the amount of additional dividends. Fully participating preference shares receive a pro rata share of all dividends declared based on the relative par value amounts of ordinary and preference shares outstanding. Most preference shares are nonparticipating.
When the preference shares are cumulative and the directors do not declare a dividend to preference shareholders, the unpaid dividend is called a dividend in arrears. All dividends in arrears on cumulative preference share must be issued in full before any dividends can be paid to ordinary shareholders. Dividends in arrears are not liabilities because they have not been declared. However, the per share and aggregate amounts of dividends in arrears must be disclosed.
Cumulative preference shares:
Unpaid dividends must be issued in full before any distributions to ordinary shareholders.
Dividends in arrears are not liabilities, but the per share and aggregate amounts must be disclosed.

15. 10,000 shares of share are issued for $100,000 cash.
Shares Issued for Cash
10,000 shares of share are issued for $100,000 cash.
Cash ,000
Ordinary share capital, par value ,000
Ordinary share premium (remainder) …… ,000
To record issue of ordinary share.
$1 Par Value
No Par Value
Cash ,000
Ordinary share capital ,000
To record issue of ordinary share.
When shares are sold for, the issued capital or share capital account is credited for the amount received from the share
issuance. When shares are issued with a designated par value, that amount is credited to the issued capital or share capital account. Proceeds in excess of this amount are credited to additional issued capital which is also called referred to as share premium.
When shares are issued without a par value, proceeds from the issuance are credited entirely to the issued capital or
share capital account.
When no-par shares are issued with a stated value, the stated value is treated like par value. The amount of stated value is credited to the issued capital or share capital account. Proceeds in excess of the stated value are credited to additional issued capital or share premium.
No Par, $1 Stated Value
Cash ,000
Ordinary share capital, stated value ,000
Ordinary share premium (remainder) … ,000
To record issue of ordinary share.

16. Shares Issued for Noncash Consideration
Apply the general valuation principle by using fair value of shares given up or fair value of assets received, whichever is more clearly evident.
If market values cannot be determined, use appraised values.
When shares of share are issued in exchange for noncash assets, we apply the general valuation principle we have seen in previous chapters. The transaction is valued at the fair value of shares issued or the fair value of assets received, whichever is more clearly evident. If the share is actively traded on an exchange, we have an objective value to use for the transaction.
If fair values cannot be determined, then we must use appraised values.

17. More Than One Security Issued for a Single Price
Allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.
Toys Ltd issued 5,000 ordinary shares, $10 par value and 3,000 preference share, $5 par value for $450,000. The market values of the ordinary shares and preference shares were $55 and $75, respectively.
Calculate the additional issued capital for each class of shares.
If more than one class of shares is issued for a single price, we must allocate the lump-sum received based on the relative fair values of the two securities.
If only one fair value is known, we allocate a portion of the lump-sum received based on that fair value and allocate the remainder to the other security.
Let’s look at an example.
Toys Ltd issued 5,000 shares of ordinary shares, $10 par value and 3,000 shares of preference shares, $5 par value for $450,000. The market values of the ordinary shares and preference shares were $55 and $75, respectively.
Calculate the additional issued capital for each class of shares.

18. More Than One Security Issued for a Single Price
Part I.
First we calculate the total market values of the shares issued by multiplying the market value per share times the number of shares issued. For ordinary share, 5,000 shares times $55 per share equals $275,000, and for preference share, 3,000 shares times $75 per share equals $225,000, and the sum of these two amounts gives us a total market value of $500,000.
Next we divide the market value of each class of share by the total market value of $500,000 to get the allocation percentages. For ordinary share, $275,000 divided by $500,000 equals 55 percent, and for preference share $225,000 divided by $500,000 equals 45 percent.
We multiply the allocation percentages times the $450,000 received to allocate the proceeds to each class of share. For ordinary share, 55 percent of $450,000 is $247,500, and for preference share, 45 percent of $450,000 is $202,500.
Finally we subtract the total par value of each class of share from the allocated amounts. For ordinary 5,000 shares times $10 par value per share equals $50,000, and for preference, 3,000 shares times $5 par value per share equals $15,000. The additional issued capital for ordinary is $247,500 minus $50,000, or $197,500. The additional issued capital for preference is $202,500 minus $15,000, or $187,500.
Now let’s record this transaction with a journal entry.
Part II.
We debit cash for the proceeds of $450,000. We credit ordinary share for its $50,000 par value and we credit preference share for its $15,000 par value. Then we credit additional issued capital for the two classes of share, $197,500 for ordinary and $187,500 for preference.
Cash ,000
Ordinary share, $10 par ,000
Ordinary share premium (remainder)……..…… ,500
Preference share, $5 par ,000
Preference share premium (remainder)………… ,500
To record issue of ordinary and preference share.

19. Share Issue Costs Registration fees Underwriter commissions
Printing and clerical costs
Legal and accounting fees
Promotional costs
When a company sells its shares to the public, it incurs certain costs called share issue costs. The costs include:
registration fees.
underwriter commissions.
printing and clerical costs.
legal and accounting fees.
promotional costs.
Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional issued capital.
Share issue costs reduce net proceeds from selling shares, resulting in a lower amount of additional issued capital.

20. Share Buybacks
A corporation might reacquire shares of its share to . . .
support the market price.
increase earnings per share.
distribute in share option plans.
distribute in a bonus issue.
use in mergers and acquisitions.
thwart takeover attempts.
A corporation might reacquire its shares for a number of reasons including:
supporting the market price.
increasing earnings per share.
for distribution in share option plans.
to distribute in a bonus issue.
for use in mergers and acquisitions.
to thwart takeover attempts.
Regardless of the reasons for repurchasing shares of share, companies can account for the repurchase in either of the follow ways:
the shares can be formally retired, or
they can be accounted for as treasury shares.
I can account for the reacquired shares by retiring them or by holding them as treasury shares.

21. Accounting for Retired Shares
When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – ordinary or preference share capital, and additional issued capital.
Price paid is less than issue price.
5,000 shares of $2 par value share that were issued for $20 per share are reacquired for $17 per share.
Part I.
When shares are formally retired, we reduce the same capital accounts that were increased when the shares were issued – ordinary or preference share capital, and additional issued capital.
Consider the following example.
Part II.
First, let’s examine the case where the price paid to reacquire the shares is less than the original issue price. The company pays $17 per share to reacquire 5,000 shares of $2 par value share, that were originally issued for $20 per share.
We record this transaction by reducing ordinary share capital with a $10,000 debit for its par value, and by reducing ordinary share premium with a debit of $90,000. We credit cash for the amount paid, 5,000 shares times $17 per share equals $85,000. Finally, we credit additional issued capital-share repurchase for $15,000, the difference between the $100,000 of proceeds from the original and the $85,000 paid to reacquire the shares.
Ordinary share capital ,000
Ordinary share premium ………………..…………… ,000
Additional issued capital – share repurchase …… ,000
Cash ……………………………………………… ,000
To record repurchase and retirement of ordinary share.

22. Accounting for Retired Shares
Price paid is more than issue price.
5,000 shares of $2 par value share that were issued for $20 per share are reacquired for $25 per share.
Ordinary share capital ,000
Ordinary share premium ………………..………………. 90,000
Additional issued capital – share repurchase ……….. 25,000
Cash ……………………………………………… ,000
To record repurchase and retirement of ordinary share.
Now let’s examine the case where the price paid to reacquire the shares is more than the original issue price. The company pays $25 per share to reacquire 5,000 shares of $2 par value share, that were originally issued for $20 per share.
We record this transaction by reducing ordinary share capital with a $10,000 debit for its par value, and by ordinary share premium with a debit of $90,000, the same entries as in the first case. We credit cash for the amount paid, 5,000 shares times $25 per share equals $125,000. Finally, we debit additional issued capital-share repurchase for $25,000, the difference between the $100,000 of proceeds from the original and the $125,000 paid to reacquire the shares. The $25,000 debit to additional issued capital-share repurchase assumes that a credit balance of at least $25,000 already exists in this account.
If the credit balance is less than $25,000, we would debit retained earnings for the amount needed.
Reduce Retained Earnings if the Additional issued capital
– share repurchase account balance is insufficient.

23. Accounting for Treasury Shares
Treasury shares usually do not have:
Voting rights.
Dividend rights.
Preemptive rights.
Liquidation rights.
Treasury shares are reported as an unallocated reduction of total Shareholders’ Equity.
Acquisition of Treasury Shares
Recorded at cost to acquire.
Resale of Treasury Shares
Treasury Shares credited for cost.
Difference between cost and issuance price is (generally) recorded in additional issued capital – share repurchase.
Treasury shares have no voting or dividend rights. Dividends are not paid on treasury shares, and a corporation holding its own shares cannot vote at the annual meeting based on those shares. In the event of liquidation, the corporation receives no portion of the liquidated assets for the shares that it holds in the treasury. Treasury shares are not assets. The purchase of treasury shares reduces assets by the amount paid for the purchase. It is reported in the shareholders’ equity portion of the statement of financial position as a reduction from total equity.
Using the cost method, we record (debit) treasury shares for the cost to purchase it. The total cost of all treasury shares held by the company is the amount reported as a reduction in shareholders’ equity.
If the treasury shares are reissued, any difference between cost and issuance price is (generally) recorded in additional issued capital – share repurchase.

24. Retained Earnings
Represents the undistributed earnings of the company since its inception.
Retained earnings may also be affected by the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment.
Any restrictions on retained earnings must be disclosed in the notes to the financial statements.
Retained earnings represents the undistributed earnings of the company since its inception. The most frequent changes to retained earnings are increases due to income and decreases due to distributions to owners, primarily dividends.
Retained earnings may also be affected by the correction of an accounting error that occurred in the financial statements of a prior period, called a prior period adjustment. Some loan agreements place restrictions on the amount of dividends that can be paid based on the balance in retained earnings. Restrictions on retained earnings are generally disclosed in the notes to the financial statements.

25. Accounting for Cash Dividends
Declared by board of directors.
Not legally
required.
Requires sufficient Retained Earnings and Cash.
Creates liability at declaration.
Declaration date
Board of directors declares a $10,000 cash dividend.
Record a liability.
Cash dividends are declared by the board of directors. There is no legal obligation to declare a cash dividend, but once declared, there is a legal obligation to pay the dividend. Most corporations that pay cash dividends pay them quarterly. To pay a cash dividend, a corporation must have two things:
 sufficient retained earnings to absorb the dividend without going negative and
enough cash to pay the dividend.
There are four important dates to remember when discussing dividends.
 declaration date.
 ex-dividend date.
 record date.
 payment date
The declaration date is the date the directors declare a $10,000 cash dividend. At this time a liability is created and must be recorded. The entry at the date of declaration includes a debit to retained earnings and a credit to dividends payable for $10,000.
Declaration Date:
Retained earnings ,000
Dividends payable ,000
To record declaration of cash dividend.

26. Dividend Dates Ex-dividend date Date of Record Date of Payment
The first day the shares trade without the right to receive the declared dividend. (No entry needed)
Date of Record
Shareholders holding shares on this date will receive the dividend. (No entry needed)
Date of Payment
Record the dividend payment to shareholders.
Part I.
The date of record is important to investors because the shares must be owned on this date to receive the dividend. Although a journal entry is not required on the record date, the company prepares a list of registered owners as of this date. The persons on that list will receive the dividend.
Registered owners of shares on this date are entitled to receive the dividend—even if they sell those shares prior to the actual cash payment.
The ex-dividend date is an important date for purchasers and owners of shares. This is the date which serves as the ownership cut-off point for the receipt of the most recent declared dividend. To be a registered owner of shares on the date of record, an investor must purchase the shares before the ex-dividend date. The ex-dividend date is usually two business days before the date of record. If you buy shares on or after the ex-dividend date but before the payment date, you will not receive the dividend. As a result, the market price of a share typically will decline by the amount of the dividend, other things being equal, on the ex-dividend date. A journal entry is not required on the ex-dividend date.
The date of payment is the date the corporation pays the dividend to the shareholders who owned the share on the record date. The entry on the date of payment includes a debit to dividends payable to remove the liability and a credit to cash for $10,000.
Date of Payment:
Dividends payable ,000
Cash ……………… ,000
To record payment of cash dividend.

27. Property Dividends Distributions of non-cash assets.
Record at fair value of non-cash asset.
Recognize gain or loss for difference between book value and fair value.
Property dividends are distributions of non-cash assets. The dividend is recorded at the fair value of the non-cash assets distributed. A gain or loss for the difference between book value and fair value of the assets distributed is recognized on the declaration date of the property dividends.

28. Accounting for Bonus Issues
Distribution of additional shares to owners.
No change in total shareholders’ equity.
All shareholders retain same percentage ownership.
No change in par values.
IFRS
U.S. GAAP
No entry needed.
But corporation laws may require reclassification within shareholders’ equity
A bonus issue is a distribution of additional shares to shareholders. Bonus issues do not change the assets or liabilities of the business. All shareholders retain the same percentage ownership. All shareholders retain the same percentage ownership. The shareholders have more shares representing the same ownership as they had before the bonus issue. There is no change in total shareholders’ equity and par value per share does not change.
Why do corporation issue bonus issues which are merely more pieces of paper evidencing the same percentage ownership?
Corporations may issue bonus issues to:
reduce the market price per share to make the shares more affordable for investors to purchase.
signal that the management expects strong financial performance in the future.
remind shareholders of the accounting wealth in the company, while preserving cash.
reduce the existing balance in retained earnings, if the corporation law of the country of incorporation requires a bonus issue to be accounted for by reclassifying an amount from retained earnings to issued capital.
In the U.S., a bonus issue is referred to as a “stock dividend”. Under U.S. GAAP, the accounting treatment for a “stock dividend” depends on its size.
For a “small stock dividend”, typically less than 25% of the existing number of outstanding shares, the fair market value of the additional shares distributed is transferred from retained earnings to ordinary share capital and additional issued capital. For a “large stock dividend”, typically 25% or higher, the par value of the additional shares distributed is transferred from additional issued capital or retained earnings to ordinary share capital.
Under IFRS, no accounting adjustments are required for a bonus issue, other than an adjustment to the number of ordinary shares outstanding for purposes of calculating basic and diluted earnings per share. However, the corporation laws of the country of incorporation may require the bonus issue to be accounted for by reclassifying amounts from one or more shareholders’ equity accounts to other issued capital accounts.
Bonus issue > 25%
Record at par value of share.
Large
Bonus issue < 25%
Record at current fair value of share.
Small

29. Accounting for Bonus Issues
CarCo declares and distributes a 1-for-5 bonus issue on 5 million ordinary shares. Par value is $1; market value is $20.
If the corporation law requires a reclassification from retained earnings to issued capital of an amount equal to the market value of the bonus shares distributed, the journal entry is:
Retained earnings (1,000,000 x $20) ,000,000
Ordinary share capital (1,000,000 x $1)…………. 1,000,000
Ordinary share premium ………………...…… ,000,000
To record declaration and distribution of bonus issue.
Additional shares distributed = 5,000,000 shares ÷5 = 1,000,000 shares
CarCo declares and distributes a 1-for-5 bonus issue on 5 million ordinary shares. Par value is $1 and market value is $20.
A 1-for- 5 bonus issue means that one additional share is issued for every five existing outstanding shares. Hence, 1,000,000 additional shares would be issued for the existing 5,000,000 outstanding shares.
If the corporation law requires the bonus issue to be accounted for by reclassifying from retained earnings to issued capital an amount equal to the market value of the additional shares issued, each share issued will be recorded at its market value of $20. So, the bonus issue will be valued at $20,000,000.
The required journal entry would be to debit retained earnings for $20,000,000, credit ordinary share capital for $1,000,000 (1,000,000 shares issued times $1 par value per share), ordinary share premium for $19,000,000 (the difference between the $20,000,000 market value and the $1,000,000 par value of the shares distributed).
If the corporation law requires the bonus issue to be accounted for by reclassifying from share premium to share capital an amount equal to the par value of the additional shares issued, each share issued will be recorded at its par value of $1. So, the bonus issue will be valued at $1,000,000.
The required journal entry would be to debit ordinary share premium for $1,000,000, and credit ordinary share capital for $1,000,000 (1,000,000 shares issued times $1 par value per share).
If the corporation law requires a reclassification from share premium to share capital of an amount equal to the par value of the bonus shares distributed, the journal entry is:
Ordinary share premium (1,000,000 x $1) ,000,000
Ordinary share capital (1,000,000 x $1)…………. 1,000,000
To record declaration and distribution of bonus issue.

30. Share Splits
Share splits change the par value per share and the number of shares outstanding, but the total share capital is unchanged, and no journal entry is required.
Assume that a corporation had 3,000 of $2 par value ordinary shares outstanding before a 2–for–1 share split.
Increase
Decrease
No Change
A share split is the distribution of additional shares to shareholders according to their percentage ownership. When a share split occurs, the corporation calls in the outstanding shares and issues new shares. In the process of a share split, the par value of the share decreases, and the number of outstanding shares increases, but total share capital is unchanged. Each shareholder has the same percentage ownership of the company after the split as before the split. A journal entry is not required to record a share split. Let’s look at an example.
Assume that a corporation had 3,000 shares of $2 par value ordinary shares outstanding before a 2–for–1 share split. After the two-for-one split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required, and that there is no change to shareholders’ equity.
In many respects a 1-for-1 bonus issue and a two-for-one share split result in similar impacts to the price per share in the share market. A share split does not require any journal entry but changes the par value per share, while a bonus issue does not change the par value per share but may require a journal entry if the corporation law of the country of incorporation requires a reclassification within shareholders’ equity.

31. Appendix 18 ─ Quasi Reorganizations
Purpose
To allow a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.
Procedures
Assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
The debit balance in retained earnings is eliminated first against additional issued capital or share premium, and then, if necessary, against ordinary share capital.
Retained earnings is dated to indicate when the new accumulation of earnings began.
Appendix 18: Quasi Reorganizations
A quasi reorganization allows a company undergoing financial difficulty, but with favorable future prospects, to get a fresh start by writing down inflated assets and eliminating an accumulated balance in retained earnings.
The following steps are followed in a reorganization:
the firm’s assets and liabilities are revalued to reflect market values, with corresponding debits and credits to retained earnings.
the debit balance in retained earnings (deficit) is eliminated first against additional issued capital or share premium, and then, if necessary, against ordinary share capital.
retained earnings is dated to indicate when the new accumulation of earnings began.

32. Quasi Reorganizations
Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval.
The statement of financial position prior to restatement, in millions, follows :
Fair values: Inventory = $300,000,000 and Property, plant, and equipment = $225,000,000.
Emerson-Walsch Corporation has incurred losses for several years. The board of directors voted to implement a quasi reorganization, subject to shareholder approval. Let’s examine the statement of financial position prior to restatement.
Notice the deficit in retained earnings. The quasi reorganization will eliminate this deficit, but first, we must restate the assets to reflect their fair values. Fair value of the inventory is $300,000,000 and fair value of the property, plant, and equipment is $225,000,000. Restating the assets to fair values that are lower than the statement of financial position carrying value will increase the deficit in retained earnings.
Let’s prepare the journal entries necessary for the quasi reorganization.

33. Quasi Reorganizations
To revalue assets
Retained earnings ………………………… ,000,000
Inventory ………………………………………… ,000,000
Property, plant, & equipment …………………… 175,000,000
To record reduction to fair value of assets.
To eliminate the deficit in retained earnings
Part I.
The inventory fair value of $300,000,000 is $75,000,000 less than the amount shown on the statement of financial position for inventory. The property, plant, and equipment fair value of $225,000,000 is $175,000,000 less than the amount shown on the statement of financial position for property, plant, and equipment. We credit inventory and property, plant, and equipment to reduce them to fair value. We debit retained earnings to absorb the reductions in inventory and property, plant, and equipment. The $250,000,000 debit to retained earnings increases the retained earnings deficit from $300,000,000 to $550,000,000.
Part II.
We credit retained earnings to eliminate the deficit (debit balance) of $550,000,000. The $150,000,000 balance in the ordinary share premium account is insufficient to absorb the entire deficit in retained earnings, so the remaining debit is to ordinary share capital for $400,000,000.
Share premium ……………….…… ,000,000
Ordinary share capital ….……………………………… ,000,000
Retained earnings ………………..……………… 550,000,000
To eliminate the deficit in retained earnings.
$300,000,000 + $250,000,000

34. Quasi Reorganizations
Statement of financial position immediately after restatement.
After the quasi reorganization, assets are stated at fair value and the deficit in retained earnings has been eliminated.

35. End of Chapter 18
End of chapter 18.