UNIT 8

AUDIT OF EQUITY ACCOUNTS

Estimated Time: 4.5 HOURS
Discussion Questions 8-1:
1. Discuss the different sources of Share Premium (Additional Paid-in Capital).
2. Discuss the different transactions affecting Retained Earnings (Accumulated
Profits).
Discussion Questions 8-2:
Choose the best answer for the following questions:
(1) The audit procedure of confirmation is least appropriate with respect to:
a. The trustee of an issue of bonds payable.
b. Holders of common stock.
c. Holders of notes receivable.
d. Holders of notes payable.
(2) An auditor is most likely to trace treasury stock purchase transactions to the:
a. Numbered stock certificates on hand.
b. Articles of incorporation.
c. Years interest expense.
d. Minutes of the audit committee.
(3) In the continuing audit of a manufacturing company of medium size, which of the
following areas would your expect to require the least amount of audit time?
a. Owners equity
b. Revenue
c. Assets
d. Liabilities.
(4) The auditors can best verify a clients bond sinking fund transactions and yearend balance by:
a. Recomputation of interest expense, interest payable, and amortization of
bond discount or premium.
b. Confirmation with individual holders of retired bonds.
c. Confirmation with the bond trustee.
d. Examination and count of the bonds retired during the year.
(5) Which of the following is most likely to be an audit objective in the audit of
owners equity?
a. Establish that recorded owners equity includes all long-term debt and equity
balances.
b. Determine that common stock is valued at current market value.
c. Determine that the presentation and disclosure of owners equity is
appropriate.
d. Determine that the existence of recorded owners equity is in conformity with
equity accounting rule valuations.
(6) When auditing a sole proprietorship, a common difficulty is lack of:
a. Segregation of personal net worth and business capital.
b. Availability of the owner.
c. Agreement as to the distribution between retained earnings and owners
capital.
d. Proper measures of dividends.
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Problem 8-1: Shareholders Equity Transactions

The shareholders equity section of Armani Corporations statement of financial
position as of December 31, 2014, is as follows:
Ordinary share capital (P6 par, 250,000
shares authorized, 147,500 issued and
outstanding)
Share premium
Total paid-in capital
Unappropriated retained earnings
Appropriated retained earnings
Total retained earnings
Total shareholders equity

885,000
442,500

963,500
350,000

1,327,500

1,313,500
P 2,641,000

Armani Corporation had the following shareholders equity transactions during 2015:
Jan. 15 Completed the building renovation for which P350,000 of retained earnings
had been restricted. Paid the contractor P328,300, all of which is capitalized.
Mar. 3

Issued 50,000 additional ordinary shares for P11 per share.

May 18 Declared a dividend of P1.50 per share to be paid on July 31, 2015, to
shareholders of record on June 30, 2015.
June 19 Approved additional building renovation to be funded internationally. The
estimated cost of the project is P400,000, and retained earnings are to be
restricted for that amount.
July 31 Paid the dividend.
Nov. 12 Declared a property dividend to be paid on December 31, 2015, to
shareholders of record on November 30, 2015. The dividend is to consist of
18,300 shares of Chanel Corporation ordinary shares that are currently
recorded in Armanis books at P9 per share.
Dec. 31 Reported P673,500 of net income on December 31, 2015 income statement.
In addition, the shares were distributed in satisfaction of the property
dividend.
Required:
1. Prepare the journal entries to record the transactions in 2015.
2. Determine the balance of the following as of December 31, 2015:
a) Ordinary share capital account
b) Share premium account
c) Unappropriated retained earnings
d) Total shareholders equity
Problem 8-2: Dividends on Ordinary Shares
Lauren Company had net income for 2015 of P8,250,000 and earnings per share on
ordinary shares of P3.20. Included in the net income was P500,000 of bond interest
expense related to its long-term debt. The income tax rate for 2015 is 30%.
Dividends on preference shares were P430,000. The dividend pay-out ratio on
ordinary shares was 40%.
Required: Compute the dividends paid on ordinary shares in 2015.
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Problem 8-3: Equity Presentation, with BV per share

Fleurage Inc. is a public enterprise whose shares are traded in the over the counter
market. At December 31, 2014, Fleurage had 6,000,000 authorized shares of P10
par value common stock, of which 2,800,000 shares were issued and outstanding.
The stockholders equity accounts at December 31, 2014, had the following balances.
Common stock
Additional paid in capital
Retained earnings

P 28,000,000
11,500,000
8,450,000

Transactions during 2015 and other information relating to the stockholders equity
accounts were as follows:

On January 5, 2015, Fleurage issued at P56 per share, 125,000 shares of P50
par value, 9% cumulative convertible preferred stock. Each share of preferred
stock is convertible, at the option of the holder, into two shares of common stock.
Fleurage had 600,000 authorized shares of preferred stock. The preferred stock
has a liquidation value equal to 125% of its par value.
On February 1, 2015, Fleurage reacquired 25,000 shares of its common stock for
P16 per share, Fleurage uses the cost method to account for treasury stock.
On April 30, 2015, Fleurage sold 650,000 shares (previously unissued) of P10
par value common stock to the public at P17 per share.
On May 13, 2015, Fleurage issued 540,000 stock rights. Five rights, plus P30 in
cash, are required to purchase one new Fleurage ordinary share. On the date of
issuance, Fleurage stock was selling for P75 per share.
On June 18, 2015, Fleurage declared a cash dividend of P1.50 per share of
common stock, payable on July 12, 2015, to stockholders record on July 1, 2015.
On November 10, 2015, Fleurage sold 10,000 shares of treasury stock for P24
per share
On December 14, 2015, Fleurage declared the yearly cash dividend on preferred
stock, payable on January 14, 2016, to stockholders of record on December 31,
2015.
On January 20, 2016, before the books were closed for 2015, Fleurage became
aware that the ending inventories at December 31, 2014 were understated by
P300,000 (gross of tax; where income tax rate is 30%). The appropriate
correction entry was recorded the same day.
After correcting the beginning inventory, net income for 2015 was P5,750,000.

Required: Compute for the following:

1) Retained earnings unappropriated
2) Stockholders equity
3) Book value per share of common (Dec. 31, 2015)
Problem 8-4: Adjusting Entries
You are engaged in the audit of the corporation, a new client, at the close of its fiscal
year, April 30, 2015. The books had been closed prior to the time you began your
year-end fieldwork.
You review the following stockholders' equity accounts in the general ledger:
Capital Stock
9/14/14

CD

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153,400

5/1/14 CR
4/28/15 J

1,950,000
145,000
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Retained Earnings
4/28/15

145,000

2/2/15 CR
4/30/15 J

100,000
800,000

Income Summary
4/30/15
4/30/15

J
J

5,200,000
800,000

4/30/15 J

6,000,000

Additional information:
1 - From the articles of incorporation:
A- Authorized capital stock - 30,000 shares
B- Par value per share - P100
2 - Directors' minutes include the following resolution:
4/30/14
9/13/14
2/1/15
4/28/15

- Authorized the issue of 15,000 shares at P130 per share.

- Authorized acquisition of 1,300 shares at P118.
- Authorized reissue of 800 treasury shares at P125.
- Declared a 10% stock dividend, payable May 31, 2016 to
stockholders on record as of April 30, 2015. The market value of the
stock on this date was P140 per share.

Required: Adjusting entries as of April 30, 2015.

Problem 8-5: Quasi-Reorganization
The DISTRICT CO. has incurred losses from operations for many years. At the
recommendation of the newly hired president, the board of directors voted to
implement a quasi-reorganization, subject to the shareholders and creditors
approval. Immediately, prior to the quasi-reorganization, on December 31, 2015, the
entitys statement of financial position is as follows:
Assets
Current assets
Property, plant and equipment
Other noncurrent assets
Total assets

P1,375,000
3,375,000
500,000
P5,250,000

Liabilities and Shareholders Equity

Total liabilities
Ordinary shares, P10 par value
Share Premium
Deficit
Total Liabilities & Shareholders Equity

P1,500,000
4,000,000
750,000
(1,000,000)
P5,250,000

The shareholders and creditors approved the quasi-reorganization effective January

1, 2016, to be accomplished by a reduction in property, plant and equipment (net)
P875,000, a reduction in other noncurrent assets of P375,000, and a reduction in par
value from P10 to P5.

Required:
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1. How much is the entitys total assets after the quasi-reorganization?

2. How much is the balance of the share premium account after the quasireorganization?
3. How much is the deficit after the quasi-reorganization?
Problem 8-6: Retained Earnings
The Unappropriated Accumulated Profit account of BISTRO CO. shows the following
debits and credits for the year 2015:
UNAPPROPRIATED ACCUMULATED PROFITS
Description

Debit

Credit

Balance, Beg.

Balance
565,500

a)

Gain on life insurance policy settlement

b)

f)

Write-off of goodwill
Effect of change in accounting policy from FIFO to weighted
average
Loss on sale of treasury shares (Share Premium is sufficient
to cover the loss)
10% share dividends on 100,000, P10 par value shares
issued and outstanding (Fair Value at the same date at
P12.50)
Officers' compensation related to income of prior periods accrual overlooked

g)

Premium on ordinary shares issued

h)
i)

Share issuance expenses (related to ordinary shares issued)

Share subscription defaults

j)
k)

Loss on sale of equipment

Gain on retirement of preference shares at less than issue
price

35,000

490,500

l)

Gain on early retirement of bonds

12,500

503,000

m)

Correction of a prior period error

45,000

548,000

n)

Cash dividends declared

75,000

o)

Inventory loss from flood

10,500

p)

Proceeds from sale of donated shares

q)

Revaluation increase in land

r)

Appropriation for plant expansion

s)

Net income for the period

c)
d)

e)

50,000
30,000

615,500
585,500

100,000

685,500

20,000

665,500

100,000

565,500

160,000

405,500
65,000

470,500

15,000

465,500
480,500

5,000
25,000

455,500

473,000
462,500
37,500

500,000

150,000

650,000

100,000

550,000
175,000

725,000

Required:
1. How much is the correct unappropriated accumulated profits restated beginning
balance?
2. How much is the adjusted net income for the year?
3. How much is the correct unappropriated accumulated profits ending balance?
Problem 8-7: Share Options
At the beginning of 2014, Lancome Company grants share options to each of its 100
employees working in the sales department. The share options will vest at the end of
2016, provided that the employees remain in the entitys employ, and provided that
the volume of sales of a particular product increases by at least an average of 5
percent per year. If the volume of sales of the product increases by an average of
between 10 percent and 15 percent each year, each employee will receive 300 share
options. If the volume of sales increases by an average of 15% or more, each
employee will receive 400 share options.
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On grant date, Lancome Company estimates that the share options have a fair value
of P34 per option. Lancome Company also estimates that the volume of sales of the
product will increase by an average of between 10% and 15% per year. The
company also estimates on the basis of weighted average probability that 19% of
employees will leave before the end of 2014.
By the end of 2014, seven employees have left and the company still expects that a
total of 19 employees will leave by the end of 2016. Product sales have increased by
12% and the company expects this rate of increase to continue over the next two
years.
By the end of 2015, a further six employees have left. The entity now expects only
four more employees will leave during 2016. Product sales have increased by 18%.
The company now expects that sales will average 15% or more over the three-year
period.
By the end of 2016, a further three employees have left. The entitys sales have
increased by an average of 16% over the three years.
Required: Compute for the following
1. Compensation expense, 2014
2. Compensation expense, 2015
3. Compensation expense, 2016
Problem 8-8: Share options with cash alternatives
Titus Company grants to an employee the right to choose either 5,500 phantom
shares1 or 7,000 shares. The grant is conditional upon the completion of three years
of service. If the employee chooses the share alternative, the shares must be held
for three years after the vesting date.
At grant date, the entitys share price is P83 per share. At the end of years 1, 2 and
3, the share price is P84, P87 and P91 respectively. The entity does not expect to
pay dividends in the next three years. After taking into account the effects of the
post-vesting transfer restrictions, the entity estimates that the grant date fair value of
the share alternative is P81 per share.
Required: Compute for the following
1. Compensation expense, year 1
2. Compensation expense, year 2
3. Compensation expense, year 3
Problem 8-9: Share Appreciation Rights
On January 1, 2014, Royce Corporation grants 120 cash share appreciation rights
(SAR) to each of its 200 employees on condition that the employee remain in its
employ for the next three years.
During 2014, 14 employees left and the company estimates that a further 24 will
leave during 2015 and 2016. During 2015, 10 employees left and the company
estimates that a further 8 will leave during 2016. During 2016, 8 employees left. At
the end of 2016, 60 employees exercised their SAR. At the end of 2017, another 40

Phantom shares represent the right of an employee to receive cash payments equivalent to
5,000 shares as if the employee were given an actual share of stock in the company. The
employee never actually owns shares and thus obtains no shareholder rights under the plan.
1

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employees exercised their SAR.

exercised their SAR.

At the end of 2018, the remaining employees

The entity estimates the fair value of the SAR at the end of each year in which a
liability exists as show below. At the end of 2016, all SAR held by the remaining
employees vest. The intrinsic values of the SAR at the date of exercise (which equal
the cash paid out) at the end of 2016, 2017, and 2018 are also shown below:
Year
2014
2015
2016
2017
2018

Fair Value
P 28
30
33
41

Intrinsic Value

P 36
39
48

Required: Compute for the following

1. Compensation expense in 2015
2. Compensation expense in 2016
3. Compensation expense in 2017
4. Compensation expense in 2018

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