CHAPTER 21

INVESTMENT IN EQUITY SECURITIES

QUESTION 21-1

When are dividends considered earned?

ANSWER 21-1

In this connection, three dates are important in accounting for dividends, namely:

1. Date of Declaration is the date on which the payment of dividends is approved by the
board of directors

2. Date of Record is the date on which the stock and transfer book is closed for
registration. Only those shareholders registered as of this date are entitled to receive
dividends.

3. Date of Payment is the date on which the dividends declared be paid.

PAS 18, paragraph 29, provides that “dividends shall be recognized as revenue when the
shareholder’s right to receive payment is established”.

Accordingly, the dividends shall be recognized as revenue on the date of declaration.

QUESTION 21-2

Describe and discuss the accounting treatment of the following:

1. Cash dividends
2. Property dividends
3. Liquidating dividends
4. Stock dividends

ANSWER 21-2

1. Cash dividends, as the title suggests, are in the form of cash. As a rule, such
dividends are treated as income but if the equity method is used, the same should be
credited to the investment account.

2. Property dividends or dividends in kind are dividends in the form of property or assets
other than cash.

The property may be in the form of another entity’s share, inventory, equipment and
other noncash asset.
 Property dividends are normally treated as income at the fair value of the property
received.

3. Liquidating dividends represent return of investment and therefore are not income.

4. Stock dividends are in the form of the issuing entity’s own shares. The IAS term for
stock dividend is “bonus issue”.

Stock dividends may be the same as those held or different from those held. Stock
dividends are not income.

Stock dividends of the same kind are recorded only by means of a memorandum entry
on the part of the investor.

Such stock dividends do not affect the total cost of the investment but reduce the cost of
the investment per share.

QUESTION 21-3

Discuss the accounting treatment of stock dividends which are different from those
held.

ANSWER 21-3

As stated earlier, stock dividends are not income whether they are the same or different
kind.

When the stock dividends are of different kind, the procedure is to allocate the cost of
the original investment between the original shares and the “different” stock dividends
on basis of fair value.

For instance, if the original investment is ordinary share and the investor receives
preference share as stock dividend, the stock dividend is recorded by debiting
investment in preference share and crediting investment in ordinary share for the
amount allocated to the stock dividend.

Accordingly, the stock dividends of different kind reduce the total cost of the original
investment because a new investment account is set up for the stock dividends received.

QUESTION 21-4

Discuss the accounting treatment for shares received in lieu of cash dividends.

ANSWER 21-4

When cash dividends are declared and received, it is without doubt that they are
income. A problem will arise when shares are received in lieu of cash dividends declared.
It is generally accepted that shares in lieu of cash dividends are income at the fair value
of shares received.

In the absence of the fair value of the shares received, the income is equal to the cash
dividends that would have been received.

Shares received in lieu of cash dividends are recorded by debiting investment in shares
and crediting dividend income.

QUESTION 21-5

Discuss the accounting treatment for cash received in lieu of stock dividends.

ANSWER 21-5

When stock dividends are declared and received, unquestionably they are not income. A
problem will arise when cash is received in lieu of stock dividends.

In this case, the “as if” approach is followed. This means that the stock dividends are
assumed to be received and subsequently sold at the cash received. Therefore, gain or
loss may be recognized.

Under the ruling of the Bureau of Internal Revenue, all cash received, whether originally
designated as cash dividend or stock dividend is income on the part of the shareholder.

However, the “as if” approach is theoretically sound and shall be followed for accounting
purposes.

QUESTION 21-6

Discuss share split and its accounting treatment

ANSWER 21-6

Share split may be split up or split down.

A share split up is a transaction whereby the outstanding shares are called in and
replaced by a larger number, accompanied by a reduction in the par or stated value of
each share.

A share split down is a transaction whereby the outstanding shares are called in and
replaced by a smaller number, accompanied by an increase in the par or stated value.

Share split does not affect the total cost of investment. But there is a decrease or an
increase in the cost per share because the total cost now will apply to a larger or smaller
number of shares.

Only a memorandum entry is made to record the receipt on new shares by virtue of
share split.
QUESTION-7

What is a stock right?

ANSWER-7

A stock right or preemptive right is a legal right granted to shareholders to subscribe

new shares issued by a corporation at a specified price during a definite period. The IAS
term for stock right is “right issue”.

A stock right is inherent in every share. A shareholder receives one right for one share
owned. A stock right is valuable to an investor because the price at which the new
shares are sold is generally below the prevailing market price.

The purpose of the stock right is to enable the shareholders to preserve their equity or
proportionate interest in the corporation.

The ownership of stock right is evidenced by an instrument or a certificate known as

share warrant.

QUESTION 21-8

Explain the procedure when stock rights are accounted for separately?

ANSWER 21-8

PAS 39 and PFRS 9 do not address this accounting issue categorically. But
unquestionably, a stock right is a form of a financial asset.

In this regard, there is a divergence of opinion among academicians and theoreticians.

There are two schools of thought on the matter, namely:

1. Stock rights are accounted for separately.

2. Stock rights are not accounted for separately.

Under PFRS 9, financial asset is recognized initially at fair value plus transaction costs
directly attributable to the acquisition of the financial asset.

Accordingly, stock rights as a form of financial assets are measured initially at fair
value.

In other words, a portion of the carrying amount of the original investment in equity
securities is allocated to the stock rights at an amount equal to the fair value of the
stock rights at the same time of acquisition.

The reason for such an allocation is that stock rights are independent of the original
shares from which they are derived.
When stock rights are issued, the investor is now the owner of two financial assets,
namely the original shares and the related stock rights.

Stock rights are normally classified as current assets if the rights are accounted
separately.

QUESTION 21-9

Explain why stock rights are not accounted for separately.

ANSWER 21-9

Stock rights are recognized as embedded derivative but a “stand-alone” derivative.

PAS 39, paragraph 10, defines an embedded derivative as a “component of a hybrid or
combined contract (host contract) with the effect that some of the cash flows of the
combined contract vary in a way similar to a stand-alone instrument”.

Paragraph 11 of PAS 39 further provides that an embedded derivative shall be

separated from the host contract and accounted for separately.

However, PFRS 9, paragraph 4.7, provides that if the host contract is within the scope of
PFRS 9, the classification requirements of PFRS 9 are applied to the combined host
contract in its entirety.

This simply means that if the host contract is a financial asset, the embedded
derivative is not separated.

Moreover, under PAS 39, paragraph 11, if the host contract is measured at fair value
through profit or loss, the embedded derivative is not separated.

Accordingly, the stock right as an embedded derivative is not accounted for separately
because the host contract “investment in equity instrument” is a financial asset
measeured at fair value through profit or loss.

QUESTION 21-10

Which approach is followed in accounting for stock rights?

ANSWER 21-10

Admittedly, this subject matter is not a well-settled issue. In fact, paragraph 11 of PAS
39 states that “this standard does not address whether an embedded derivative shall be
presented separately in the statement of financial position”.

The authors strongly believe that the approach “not accounted for separately” stands
on solid and authoritative ground.

However, let us wait and see what Financial Reporting Standard Council will say on this
accounting issue.
QUESTION 21-11

What is the meaning of “theoretical” or “parity” value of stock right? How is it

computed?

ANSWER 21-11

The theoretical or parity value is the assumed fair value of the stock right that is derived
from the market value of the share.

The formulas for the computation of the theoretical or parity value of the stock are:

1. When the share is selling right-on:

Market value of share

right-on minus
subscription price
______________________ = Value of one right

Number of rights to purchase

one share plus 1

2. When share is selling ex-right:

Market value of share

ex-right minus
subscription price
_______________________= Value of one right

Number of rights to purchase

one share

QUESTION 21-12 Multiple choice (ACP)

1. It is the date on which the stock and transfer book of the entity is closed for
registration. Only these shareholders registered as of this date are entitled to receive
dividends.

a. Date of declaration
b. Date of record
c. Date of payment
 d. Date of mailing the dividend check

2. At which of the following dates has the shareholder theoretically realized income from
dividend?

a. The date the dividend is declared

b. The date of record
c. The date the dividend check is mailed by the entity
d. The date the dividend check is received by the shareholder

3. Property dividends are recorded as

a. Dividend income at carrying amount of the property

b. Dividend income at fair value of the property
c. Return of investment and therefore credited to investment account
d. Memorandum entry

4. Liquidating dividends are credited to

a. Income
b. Retained earnings
c. Investment account
d. Share capital

5. What is the effect of stock dividend of the same class?

a. Increase in investment amount and increase in cost per share

b. Decrease in investment account and decrease in cost per share
c. No effect on investment account but decrease in cost per share
d. No effect on investment account but increase in cost per share

6. When stock dividends of different class are received

a. No formal entry is made but only a memorandum

b. Cash is debited and dividend income is credited
c. A new investment account is debited and dividend income is credited.
d. A new investment account is debited and the original investment account is credited

7. Shares received in lieu of cash dividend are recorded as

a. Income at fair value of the shares received
b. Income at par value of the shares received
c. Income at the cash dividend that would have been received
d. Stock dividends

8. Cash received in lieu of stock dividends is accounted for as

a. Dividend income
b. Return of investment
c. Partly dividend income and partly return of investment
 d. If the stock dividends are received and subsequently sold at the cash received and
gain or loss is recognized

9. What is the effect of share split up?

a. Increase in number of shares and increase in cost per share

b. Decrease in number of shares and decrease in cost per share
c. Increase in number of shares and decrease in cost per share
d. Decrease in number of shares and increase in cost per share

10. An investor owns 10% of the ordinary shares of an investee throughout the year.
The investee has no preference shares outstanding. The investor’s interest gives the
right to

a. Be paid 10% of the investee’s profits in cash each year.

b. Receive dividend equal to 10% of the par value each year
c. Receive dividends equal to 10% of the total dividend paid by the investee for the
year to shareholders
d. Keep investee from issuing any additional shares unless the investor is willing to buy
10% of the newly issued shares

ANSWERS 21-12

1. b 6. d
2. a 7. a
3. b 8. d
4. c 9. c
5. c 10. c