ACCCOB2 Chapter 9 - Corporations: Organization and Share Capital Transactions

What is a corporation?

A corporation is an ARTIFICIAL being created by the operation of law, having the right of succession and the powers, attributes, and properties expressly authorized by law or incident to its existence. (Section 2, Revised Corporation Code of the Philippines)

Characteristics of a Corporation - Separate Legal Entity

The corporation is viewed as a separate and distinct person from its owners. It can transact business using its own name and not of its owners.

Characteristics of a Corporation - Unlimited Life

The corporation is granted a legal life of not exceeding 50 years and can be extended for multiple of 50-year periods thereafter. Under the Revised Corporation Code, a corporation shall have a perpetual existence unless otherwise provided in its articles of incorporation.

Characteristics of a Corporation - Limited Liability

Unlike a partnership, a corporation has limited liability which means that all of the unsettled obligations of the corporation at the time of its dissolution and liquidation will not extend to the personal assets of its shareholders.

Characteristics of a Corporation - Capital Acquisition

A corporation can expand its capital base by acquiring debt and equity. It can sell shares to new investors and larger corporations can issue bonds to obtain a significant amount of debt financing.

Characteristics of a Corporation - Dividends

A corporation pays its investors by issuing dividends to them. This differs from the distributions made from a partnership or sole proprietorship to pay their owners.

Characteristics of a Corporation - Double Taxation

A corporation pays income tax on its earnings. If it also pays a dividend to its investors, the investor must pay income tax on the dividends received. This constitutes double taxation of the corporation's earnings.

Characteristics of a Corporation - Ownership

Ownership in a corporation is based on the number of shares owned. Buying or selling these shares shifts the ownership of a corporation to a different investor. Publicly listed corporations may have thousands or millions of owners.

Characteristics of a Corporation - Professional Management

In many cases, the investors who own a company are not actively engaged in its management. Instead, they hire professional managers to handle the oversight of the business on their behalf.

Components of a Corporation

- Incorporators - the original owners or founders of the corporation. Their names are listed in the Articles of Incorporation.

- Corporators - the people who compose the corporation at any point in time. They include incorporators, shareholders, or members

- Shareholders - they are the corporators or owners of a STOCK corporation.

- Members - they are the corporators or owners of a NON-STOCK corporation.

- Subscribers - are those who agreed to acquire and pay shares of stock of the corporation.

- Promoters - are those who bring about or cause the formation and organization of a corporation.

- Underwriters - generally, they are investment bankers who help the corporation in the issuance of its shares of stock.

What is Articles of Incorporation?

It is a set of formal documents filed with a government body like the SEC to legally document the creation of a corporation.

What is By-Laws?

It is the document that summarizes how the corporation's affairs are carried out and managed. This should be adopted by the corporation within one month after receipt of the Certificate of Incorporation from the SEC.

Rights of Shareholders

- To share in the profits of the corporation.

- To vote in the election of the board of directors and participate in making policies.

- To subscribe to additional shares to be issued by the corporation ahead of others (right of pre-emption/pre-emptive right).

- To share in the net assets of the corporation in the event of liquidation.

What is Share Capital?

- It represents ownership in a corporation, the basic unit of which is a share of stock. This share of stock is normally classified into Ordinary Shares (mandatory) and Preference (optional) Shares.

- It is the basic shares of the corporation. If the corporation has only one class of shares, it is assumed to be ordinary shares, whether or not it is labeled as such.

- Only ordinary shares have the right to vote in the board of directors' and shareholders' meetings.

Preference Share Capital

Preference shares normally have priority over ordinary shares. This advantage is classified as:

- Preference as to Assets - this means that the preference shares would be given first priority in asset distribution in the event of corporate liquidation.

- Preference as to Dividends - this means that the preference shares are to receive first their fixed or basic dividend rate before any dividend could be given to ordinary shares.

Classification of Preference as to Dividends

- Cumulative preference share - preference share is entitled to receive dividends in arrears. Dividends in arrears are dividends to preference shareholders in any given year that were not declared for distribution by the corporation.

- Participating preference share - preference share participates pro-rata with ordinary share any excess dividend after both have received their basic dividend.

Methods of Journalizing Share Transactions

- Memorandum entry method

- Journal entry method

Basic Steps in Recording Share Transactions

1) Share authorization
2) Subscription
3) Collection of subscription
4) Issuance of share certificate

Pro-forma Equity Accounts - Share authorization

To record share authorization from the SEC, the accounts involved under the journal entry method are:

Debit Unissued Share Capital
Credit Authorized Share Capital

- Unissued Share Capital - this represents the total par value of shares that may be offered for subscription as authorized by the SEC. This account has a normal DEBIT balance.

- Authorized Share Capital - this also represents the total par value of shares as authorized by the SEC. This account has a normal CREDIT balance and the amount originally credited to this account will not change unless there is another authorization for additional shares.

*There is no formal journal entry for the share authorization under the memorandum entry method. Only a memo records the authorization.

Pro-forma Equity Accounts - Subscription

To record share subscriptions, the accounts involved under both methods are:

Debit Subscription Receivable
Credit Subscribed Share Capital

- Subscription Receivable - this represents the total amount of shares subscribed (no. of shares subscribed x subscription price per share). This account has a normal DEBIT balance.

- Subscribed Share Capital - this represents the total par value of shares subscribed (no. of shares subscribed x par value per share). This account has a normal CREDIT balance.

Pro-forma Equity Accounts - Collection of Subscription

To record the collection of subscriptions, the accounts involved under both methods are:

Debit Cash
Credit Subscription Receivable

Pro-forma Equity Accounts - Issuance of Share Certificate

To record the issuance of the share certificate, the accounts involved under the MEMORANDUM entry method are:

Debit Subscribed Share Capital
Credit Share Capital

To record the issuance of the share certificate, the accounts involved under the JOURNAL entry method are:

Debit Subscribed Share Capital
Credit Unissued Share Capital

Share Premium

This represents the excess of the amount of consideration received over the par value of the shares subscribed or issued. This account has a normal CREDIT balance.

Treasury Share

This represents shares already issued but later reacquired by the corporation. This account has a normal DEBIT balance.

Treasury share is accounted for using the cost method. When the corporation records treasury shares, the accounts involved are:

Debit Treasury Share
Credit Cash

- When the corporation reissues treasury share for cash, and the amount of cash received is higher than the cost of the treasury share, the accounts involved are:

Debit Cash
Credit Treasury Share (at cost)
Credit Share Premium - Treasury Share

- When the corporation reissues treasury share for cash, and the amount of cash received is lower than the cost of the treasury share, the accounts involved are:

Debit Cash
Debit Share Premium - Treasury Share
Credit Treasury Share (at cost)

- When the corporation reissues treasury shares for cash, and the amount of cash received is lower than the cost of the treasury share, and the balance of Share Premium - Treasury Share is not sufficient to cover the difference, the accounts involved are:

Debit Cash
Debit Share Premium - Treasury Share
Debit Retained Earnings
Credit Treasury Share (at cost)

What is Shareholders' Equity?

It is the capital section of the Statement of Financial Position of a corporation. It is comprised of the following subsections:

- Contributed Capital
- Retained Earnings
- Treasury Shares

Contributed Capital (Paid-In Capital)

It represents corporate capital arising from investment by shareholders. It is composed of Share Capital and Share Premiums.

- Share Capital - the unit of ownership by a shareholder in the assets of a corporation. It is the total of:

1) Share Capital - Preference and Ordinary
2) Subscribed Share Capital - Preference and Ordinary
3) Subscription Receivable - Preference and Ordinary (deduction)
4) Share Dividend Distributable - Preference and Ordinary

- Share Premiums - this is the total of all share premiums as follows:

1) Share Premium - Ordinary and Preference
2) Share Premium - Stated Value (ordinary)
3) Share Premium - Ordinary and Preference Treasury Share
4) Share Premium - Ordinary and Preference Share Dividend (only for small shares)

Legal Capital

This is the amount of a company's equity that cannot legally be allowed to leave the business. It cannot be distributed through a dividend or any other means. It is the par value/stated value of ordinary and preference shares that a business has issued to investors and is the total of:

- Share Capital - Ordinary and Preference
- Subscribed Share Capital - Ordinary and Preference
- Share Dividend Distributable - Ordinary and Preference
- Share Premium - Stated Value

Retained Earnings (Accumulated Profits)

It is a portion of shareholders' equity that represents the net accumulated profits earned by the corporation since its creation.

There are two kinds of retained earnings:

- Free (Unappropriated) - the portion of retained earnings that can be declared as a dividend

- Appropriated - the portion of retained earnings that has been set aside for some special purposes and is not available for dividend declaration

Reasons for Appropriating Retained Earnings

- Legal Appropriation - created based on the requirements of the law or statute under which the corporation is created. An example is Retained Earnings Appropriated for Treasury Shares.

- Contractual Appropriation - previous contracts related to bond indentures frequently contain requirements that retained earnings in specified amounts be appropriated each year during the life of the bonds. An example is Retained Earnings Appropriated for Bond Sinking Fund.

- Voluntary/Discretionary Appropriation - management may wish to preserve the funds for expansion or for covering possible losses or contingencies. An example is Retained Earnings Appropriated for Plant Expansion.

Deficit

A deficit is a retained earning that has a DEBIT balance; hence it is presented as a negative amount in the statement of shareholders' equity with the label Deficit.

Capital Deficiency

Capital deficiency is a shareholders' equity that has a DEBIT balance. This occurs when the Deficit exceeds the total of the other shareholders' equity accounts.

Treasury Share

This is a share that was previously issued and reacquired by the issuing corporation. The cost of treasury shares is DEDUCTED from the total of Contributed Capital and Retained Earnings.