Accounting for Share Capital Transactions | Commerce & Accountancy Optional Notes for UPSC PDF Download

Introduction

IFRS lacks comprehensive guidance on the specific accounting treatment for share capital transactions, including the issuance of shares with different equity instrument classes. This post provides recommendations on how to account for these transactions, aligning with the principles of IFRS. The suggestions are primarily derived from other authoritative sources, particularly the widely adopted U.S. GAAP. It is important to note that these recommendations are made to illustrate a diverse range of actual transactions that frequently require accounting treatment.

Preferred Shares

• Common and Preferred Shares:
  • Ownership in a corporation comprises common and optionally preferred shares.
  • Common shares represent residual risk-taking ownership after meeting creditor claims and senior equity class obligations.
• Preferred Shareholders:
  • Preferred shareholders have certain rights superior to common shareholders, either related to earnings or corporate assets.
• Preferences in Earnings and Assets:
  • Preferences in earnings exist with stipulated dividend rates, while preferences in assets involve a specific liquidation value for preferred shares.
• Features of Preferred Shares:
  • Preferred shares may have additional features like participation in earnings beyond the stipulated rate, cumulative rights ensuring dividend satisfaction before common shareholders, and convertibility or call ability.
• Disclosure of Preferences:
  • Any existing preferences must be adequately disclosed in financial statements, either in the statement of financial position or accompanying notes.
• Limitations on Preferred Shareholder Rights:
  • In exchange for preferences, preferred shareholders have limited rights, such as restricted voting rights.
  • The key limitation is the exclusion from unlimited participation in corporate earnings, benefiting common shareholders in cases of substantial earnings.
• Participation Limits for Preferred Shares:
  • Even if preferred shares participate, there is usually an upper limit, such as a cumulative dividend and a specified participation percentage.
• Multiple Classes of Common Shares:
  • Several classes may be labeled as common (e.g., Class A, Class B), but only one truly represents the residual equity interest.
  • Other classes, even if named common, likely possess preferential status, often related to voting rights.
• Full Disclosure of Shareholder Rights:
  • The rights and responsibilities of each shareholder class, even those labeled common, must be fully disclosed in financial statements.

Accounting For the Issuance Of Shares

• Accounting for Sale of Shares:
  • The accounting treatment for the sale of shares by a corporation depends on whether the share capital has a par or stated value.
• Par or Stated Value:
  • If there is a par or stated value, the proceeds representing the aggregate par or stated value are credited to the common or preferred share capital account.
• Legal Capital and Additional Contributed Capital:
  • The aggregate par or stated value is considered legal capital not subject to distribution.
  • Proceeds exceeding par value are credited to an additional contributed capital account, representing the amount available for distribution under defined conditions.
• Sale Below Par Value:
  • When shares are sold below par value, the share capital account is credited for par value.
  • An offsetting discount account is debited for the difference between par value and the actual amount received.
• Discount on Original Issue:
  • A discount on the original issue of share capital serves as notice to creditors about the contingent liability of investors.
  • Corporations often avoided this issue by reducing par values to prevent selling shares below par.
• Reduction in Par Values:
  • Reducing par values eliminates the risk of selling shares below par.
  • In cases where laws treat par value and amounts above par equally, the entire proceeds from share sales can be credited to the common share capital account without distinguishing between share capital and additional contributed capital accounts.
• Example Entries: The accounting entries illustrate these concepts, ensuring proper recording of share sale transactions.
  Dharma Corporation sells 100,000 shares of $5 par common share for $8 per share cash.
  [Debit]. Cash = 800,000
  [Credit]. Common share = 500,000
  [Credit]. Additional contributed capital = 300,000
  Dharma Corporation sells 100,000 shares of no-par common share for $8 per share cash.
  [Debit]. Cash = 800,000
  [Credit]. Common share = 800,000
  Preferred shares will often be assigned a par value because in many cases the preferential dividend rate is defined as a percentage of par value (e.g., 5%, $25 par value preferred share will have a required annual dividend of $1.25). The dividend can also be defined as a euro amount per year, thereby obviating the need for par values.

Share Capital Issued For Services

• Non-Cash Issuance of Shares:
  • When a corporation issues shares in exchange for services or property instead of cash, the transaction should be recorded at the fair value of the received services or property.
• Fair Value Determination:
  • If fair value information is unavailable, the transaction should be recorded at the fair value of the shares issued.
  • Appraisals, if necessary, should be obtained for an accurate reflection of the transaction.
• Valuation by Board of Directors:
  • As a last resort, the board of directors can provide a valuation for the shares issued in such transactions.
• Shares Issued for Employee Compensation:
  • Shares issued to employees as compensation for services should be accounted for at the fair value of the services rendered, if determinable, or the value of the shares issued.
• Direct Compensation by Controlling Owners:
  • In certain situations, controlling owners, especially in start-up operations with limited working capital, may directly compensate vendors or employees with shares.
  • If a major shareholder gives shares directly to an employee for services, this should be treated as a capital contribution by the major shareholder and compensation expense for the company.
• Conformity with Accounting Principles:
  • Accounting for non-cash transactions in this manner ensures conformity with the general principle that all costs incurred by an entity, including compensation, should be accurately reflected in its financial statements.

Issuance of Share Units

• Issuing Common and Preferred Shares as a Unit: Sometimes, investors may be offered common and preferred shares together as a unit (e.g., one preferred share and two common shares as a package).
• Allocation Based on Market Values: If both classes are publicly traded, proceeds from the unit offering should be allocated proportionally to their relative market values.
• Allocation with Only One Publicly Traded Security: If only one class is publicly traded, proceeds should be allocated to the traded security based on its known market value, with any excess allocated to the other.
• Unknown Market Values: When the market value of neither security is known, appraisal information may be used for allocation.
• Imputed Fair Value Based on Dividend Rate: The imputed fair value of preferred shares can be determined based on the stipulated dividend rate.
• Allocation to Common Shares: After imputing the value of preferred shares, any remaining proceeds are allocated to common shares.
• Application to Other Securities: Similar procedures apply if a unit offering involves equity and non-equity securities (e.g., convertible debentures) or shares and rights to purchase additional shares for a fixed period.

Accounting For Share Subscriptions

• Share Subscriptions in Newly Organized Corporations:
  • In newly organized corporations, contracts may be established with prospective investors outlining the purchase of specified shares over an installment period.
• Distinguishing Share Subscriptions:
  • Share subscriptions differ from actual share issuances, and their accounting treatment varies, especially in cases governed by jurisdictional laws.
• Accounting for Subscriptions Receivable:
  • The amount of share subscriptions receivable can be treated as an asset, categorized as current or noncurrent based on payment terms.
• Treatment of Subscriptions Receivable:
  • Subscriptions receivable are often shown as a reduction of shareholders' equity, akin to treasury shares.
• Distinct Accounting for Subscribed Shares:
  • Subscribed shares, lacking the rights of actual outstanding shares, are credited to a shares subscribed account rather than the share capital accounts.
• Common Shares with Par or Stated Value:
  • If common shares have par or stated value, the common shares subscribed account is credited for the aggregate par or stated value.
  • Any excess is credited to additional contributed capital, without distinction between issued and subscribed shares.
• Common Shares with No Par or Stated Value:
  • When there is no par or stated value, the entire amount of common shares subscribed is credited to the shares subscribed account.
• Collection of Amount Due:
  • As payments are collected from prospective shareholders, the share subscriptions receivable account is credited, and the cash account is debited.
• Actual Issuance of Shares:
  • The issuance of shares is deferred until full payment of the share subscription.
  • The debit to common shares subscribed is made only when subscribed shares are fully paid for and officially issued.

The following journal entries illustrate these concepts:
1.  10,000 shares of $50 par preferred are subscribed at a price of $65 each; a 10% down payment is received.
[Debit]. Cash = 65,000
[Debit]. Share subscriptions receivable = 585,000 [Credit]. Preferred share subscribed = 500,000 [Credit]. Additional contributed capital = 150,000
2. 2,000 shares of no par common shares are subscribed at a price of $85 each, with one-half received in cash.
[Debit]. Cash = 85,000
[Debit]. Share subscriptions receivable = 85,000
[Credit]. Common share subscribed = 170,000
3. All preferred subscriptions are paid, and one-half of the remaining common subscriptions are collected in full and subscribed shares are issued.
[Debit]. Cash [$585,000 + ($85,000 × 0.50)] = 627,500
[Credit]. Shares subscriptions receivable = 627,500
[Debit]. Preferred shares subscribed = 500,000
[Credit]. Preferred share = 500,000
[Debit]. Common shares subscribed = 127,500
[Credit]. Common shares ($170,000 × 0.75) = 127,500
When the company experiences a default by the subscriber, the accounting will follow the provisions of the jurisdiction in which the corporation is chartered. In some of these, the subscriber is entitled to a proportionate number of shares based on the amount already paid on the subscriptions, sometimes reduced by the cost incurred by the corporation in selling the remaining defaulted shares to other shareholders.
In other jurisdictions, the subscriber forfeits the entire investment on default. In this case the amount already received is credited to an additional contributed capital account that describes its source.

How To Distinguish Additional Contributed Capital (From The Par Or Stated Value Of The Shares)?

• Issuance of Share Capital with Par or Stated Value:
  • Entities may issue share capital with a par or stated value, often nominal, such as $1 or even $0.01.
• Market-Driven Issuance Price:
  • The actual issuance price is usually higher and market-driven.
  • The excess over the par or stated value can be assigned to a separate equity account, termed premium on capital shares or additional contributed capital.
• Legal Distinction and Financial Reporting:
  • The legal distinction between common shares and additional contributed capital is generally minimal but may be maintained for financial reporting reasons.
• Additional Contributed Capital Definition:
  • Additional contributed capital includes all capital contributions to a corporation beyond the defined par or stated value.
  • Arises from proceeds exceeding par or stated values in the sale of common and preferred shares.
• Sources of Additional Contributed Capital:
  • Arises from various transactions, including the sale of previously issued shares reacquired by the corporation (treasury shares).
  • Also from the retirement of previously outstanding shares, payment of share dividends at market value, lapse of share purchase warrants, or forfeiture of share subscriptions.
• Other Sources of Additional Contributed Capital:
  • Includes warrants detachable from bonds, conversion of convertible bonds, gains on the company's own shares (e.g., certain share option plans).
• Description in Financial Statements:
  • When material, the financial statements should describe the sources of additional contributed capital.