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Chapter 7.6® - Costs of Share Issues & Accounting for Retirement of Shares & Corresponding Rules

Share Issue Costs:

The expenditures include registration fees, underwriter commissions, legal and accounting fees, printing costs, clerical costs and promotional costs are called ‘Shares issue Costs’.

Two methods of accounting for share issue costs are found in practice:

1) Offset method

2) Retained Earnings Method

Both methods are found in practice.

Retirement of Shares:

Some preferred shares are retractable, which means that, at the option of the shareholder, and at a contractually arranged price, a company is required to buy back its shares. Other preferred shares are callable, or redeemable, which means that there are specific buy-back provisions, at the option of the company. In these transactions, the company deals directly with the shareholder. However, a company can buy back any of its shares, preferred or common, at any time, if they are offered for sales. Such a sales can be a private transaction, or a public transaction.

Reasons for Shares Retirement:

- Increase Earning Per Share

- Provide cash flow to shareholders in lieu of dividends

- Acquire shares when they appear to be undervalued

- Buy out one or more particular shareholders and to thwart takeover bids

- Reduce future dividends payments by reducing the shares outstanding

Retirement Accounting Rules:

When shares are purchased and immediately retired, all capital items relating to the specific shares are removed from the accounts. If cumulative preferred shares are retired and there are dividends in arrears, such dividends are paid and charged to retained earnings in the normal manner. Where the reacquisition cost of the acquired shares is different from the average original issuance price, the cost be allocated as follows for non-par shares:

• When the reacquisition cost is lower than the average price per share issued to date, the cost should be charged;

a) first, to share capital, at the average price per issued share; and then

b) any remaining amount, to a separate contributed capital account.

• When the reacquisition cost is higher than the average price per share issued to date, the cost should be charged in this sequence:

a) first, to share capital, at the average price per issued share;

b) second, to any contributed capital that was created by earlier cancellation or resale transactions in the same class of shares; and then

c) any remaining amount, to retained earnings.


Lets assume that Fresco has 200,000 no-par common shares outstanding, and that there is $1 million in the common share account, which yields an average issuance price per share of $5. The contributed capital account from previous retirement transactions of common shares has a $7,200 credit balance. The corporation acquired and retired 10,000 shares at a price of $6.25 per share. The shareholder who sold these shares back to Fresco had originally paid $4 per share. The transaction would be recorded as:

January 10th, 2009

Account Name

Dr. Common Shares ([{$1,000,000 / $200,000} X 10,000 shares   $50,000  
Dr. Contributed capital, common share retirement   $7,200  
Dr. Retained earnings ($62,500 - $50,000 - $7,200)
  Cr. Cash (10,000 X $6.25)   $62,500

The first step in constructing this journal entry is to compare the cost to retire the shares ($62,500) with the average initial issuance price to date ($50,000). The specific issue price of these shares ($4) is irrelevant. The corporation paid $12,500 more to retire these shares than the average original proceeds. The $12,500 is debited first to contributed capital from prior share retirements until that account is exhausted.

This account may never have a debit balance. Retained earnings is debited for the balance. The effect of this transaction is to reduce paid-in capital by $57,200, retained earnings by $5,300 and total shareholders’ equity by $62,500. Assets are reduced by $62,500.

If the shares were reacquired for $4.25 per share, the entry to record the transaction would be:

January 10th, 2009

Account Name

Dr. Common Shares [($1,000,000 / 200,000) X 10,000   $50,000  
  Cr. Contributed capital, common share retirement ($50,000 - $42,500)
Cr. Cash (10,000 X $4.25)   $42,500

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