The Securities and Exchange Commission issued Financial Reporting Bulletin 1 to 5 on February 16, 2012 followed by Financial Reporting Bulletin 6 to 12 on April 3, 2012.  Among these is Bulletin 006, which discusses accounting for deposits for future subscriptions.  “Will the deposit be accounted as a liability or part of the stockholders equity?” is a question, answer of which depends if it meets the criteria set forth under Bulletin 006.

This bulletin was further amended on January 24, 2013 with the following major revisions:

1. Inclusion of the provision of Philippine Financial Reporting Standards for Small and Medium-sized Entities (PFRS for SMEs) in the guidance which emphasizes and clarifies that SMEs are also covered by this bulletin.
2. Citing specific provision in the Corporation Code of the Philippines on the required approval of the board of directors and stockholders.
3. Requiring that the approval of the proposed increase in capital stock has been filed with the Commission, from the old minimum requirement that it has been presented for filing.
4. Clarifying that the corporation should not be contractually obliged to return the consideration received and that the corporation is obliged to deliver a fixed number of its own shares of stock for a fixed amount of cash or property paid or to be paid by the contracting party.
5. Clarifying the minimum disclosure requirements with respect to the subject transaction.

The Revised Bulletin 006 now reads as follows:

Section 22.3 of PFRS for SMEs and par. 11 of PAS 32, Financial Instruments: Presentation, defines an equity instrument as “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.”  The standards provide that “a contract that will be settled by the entity delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument.”

Under Section 36 of the Corporation Code of the Philippines (“Code”), a corporation has the power to issue or sell stocks to subscribers in accordance with the Code.  The requirements for the issuance of shares are provided under Section 38 of the Code which provides, as follows:

“SEC. 38. Power to increase or decrease capital stock; incur, create or increase bonded indebtedness. — No corporation shall increase or decrease its capital stock or incur, create or increase any bonded indebted­ness unless approved by a majority vote of the board of directors and, at a stockholders’ meeting duly called for the purpose, two-thirds (2/3) of the outstanding capital stock shall favor the increase or diminution of the capital stock, or the incurring, creating or increasing of any bonded indebtedness.  Written notice of the proposed increase or diminution of the capital stock or of the incurring, creating, or increasing of any bonded indebtedness and of the time and place of the stockholders’ meeting at which the proposed increase or diminution of the capital stock or the incurring or increasing of any bonded indebtedness is to be considered, must be addressed to each stockholder at his place of residence as shown on the books of the corporation and deposited to the addressee in the post office with postage prepaid, or served personally.

A certificate in duplicate must be signed by a majority of the directors of the corporation and countersigned by the chairman and the secretary of the stockholders’ meeting, setting forth:

x x x    x x x

Any increase or decrease in the capital stock or the incurring, creating or increasing of any bonded indebtedness shall require prior approval of the Securities and Exchange Commission.”

Considering the requirements of the Corporation Code on increase in authorized capital stock and PAS 32 or Section 22.3 of PFRS for SMEs defining an equity instrument as “any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities,” it can be held that the contract or agreement between the corporation and its contracting party (i.e., a stockholder or an investor) must create a right in favor of that party to claim over the residual interest in the net assets of the corporation.  Such right could only arise when there are Board of Directors’ and stockholders’ approvals and, most importantly, regulatory imprimatur over the increase in capital stock.

In view of the foregoing, an entity shall classify a contract to deliver its own equity instruments under equity as a separate account (e.g., Deposit for Stock Subscription) from “Outstanding Capital Stock” if and only if, all of the following elements are present as of end of the reporting period:

(1)    The unissued authorized capital stock of the entity is insufficient to cover the amount of shares indicated in the contract;

(2)    There is Board of Directors’ approval on the proposed increase in authorized capital stock (for which a deposit was received by the corporation);

(3)    There is stockholders’ approval of said proposed increase; and

(4)    The application for the approval of the proposed increase has been filed with the Commission. 

It is understood from the foregoing that there is a subscription agreement which, among other things, states that the corporation is not contractually obliged to return the consideration received and that the corporation is obliged to deliver a fixed number of its own shares of stock for a fixed amount of cash or property paid or to be paid by the contracting party.

In its financial statements for the reporting period, the corporation shall disclose at a minimum the following information with respect to the subject transaction, among other things:

(a) the value received and nature of such consideration (whether cash or noncash and if noncash, the basis of measurement);

(b) the relationship with the contracting party (i.e., stockholder, investor, or other related party (indicate relationship);

(c)  the treatment used in the recognition of the transaction (whether as an equity or a liability) and the reason for such recognition;

(d) if the transaction has been recognized as an equity, the fact that the corporation has met all the conditions required for such recognition as at the end of the reporting period (disclose relevant dates of approvals and filing);

(e)  information about the increase in the authorized capital stock (i.e., old and new authorized capital stock, number of shares, par value per share, etc.); and

(f)   if the approval is obtained subsequently before the issuance of the financial statements, the date of the Commission’s approval.

All companies that adopted either PFRS for SMEs or the full PFRS as their financial reporting framework should have observed the strict definition of equity instruments under Section 22.3 or PAS 32 that have been effective since 01 January 2010 and 01 January 2005, respectively.

Recall that the contents of the OLD Bulletin are as follows:

Bulletin 006: Deposit for Future Subscriptions 

PAS 32 defines an equity instrument as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Such residual interest arises from holding shares of stock as provided in the Corporation Code (the Code).

Under the Code, a stock corporation is empowered to issue or sell stocks to subscribers in accordance with the provisions of the Code. Such issuance should only be to the extent of the capital stock approved or authorized by the Commission. If there is no more authorized capital stock, an increase thereof for the purpose of issuing additional stocks may be made by the company subject to the approval by its Board of Directors, stockholders and the Commission.

On the basis of the foregoing, a company should not consider a deposit for future subscription as an equity instrument unless all of the following elements are present:

• There is a lack or insufficiency of authorized unissued shares of stock to cover the deposit;
• The company’s Board of Directors and stockholders have approved an increase in capital stock to cover the shares corresponding to the amount of the deposit; and,
• An application for the approval of the increase in capital stock has been presented for filing or filed with the Commission.

If any or all of the foregoing elements are not present, the transaction should be recognized as a liability.