Chapter 7.5® - Non-Cash Sales of Share Capital, Proportional & Incremental Methods of Share Issuance & Accounting
If a corporation issues shares for non-cash assets or services or to settle debt, the transaction should be recorded at fair value. But keeping in mind that that there are two fair values present, the fair value of the asset received and the fair value of the shares issued. Now, you will think, which one we should use? The answer is the cost assigned to asset received is the fair value of the consideration given.
Salees Corporation privately placed 150,000 preferred shares and 500,000 common shares, primarily in exchange for real estate. Suppose the value of the land was $620,000 assessed. And the value of shares were assessed as $650,000.
Basket Sale of Share Capital:
When a corporation sells more than one class of shares for one lump-sum amount is called basket sale. In addition, a corporation may issue two or more classes of its share capital in exchange for non-cash consideration.
When two or more classes of securities are sold and issued for a single lump sum, the total proceeds must be allocated logically among the several classes of securities. Two method are used in such scenarios:
In the proportional method, the lump sum received is allocated proportionately among the classes of shares on the basis of the relative market value of each security. In the incremental method, the market value of one security is used as basis for that security and the remainder of the lump sum is allocated to the 0ther class of security. If there is no market value for any of the issued securities, proceed may be allocated arbitrarily.
i) Proportional Method:
The common shares were selling at $40 per share and the preferred at $20. Assume the total cash received is $48,000. Because reliable market values are available for both share classes, the proportional method is preferable as a basis for allocating the lump-sum amount as follows:
ii) Incremental Method
The common shares were selling at $40; a market for the preferred has not been established. Because there is no market for the preferred shares, the market value of the common ($40,000) must be used as a basis for the following entry:
When there is no established market for either class of shares, neither the proportional method nor the incremental method of allocation can be used. In this case, an arbitrary allocation is used. In the absence of any other any other logical basis, a temporary allocation may be made by the board of directors. If a market value is established for one of the securities in the near future, a correcting entry based on such value would be made.
When the issue involves only a mix of equity, the arbitrariness of an allocation does not really matter; the classification of the proceeds between different classes of shares does not affect anyone’s rights or interests.