Equity transactions are common in business operations and can include various activities, such as issuing shares to raise capital, repurchasing shares to return capital to shareholders, or canceling shares to reduce the share capital. These transactions often entail costs, such as legal fees, underwriting fees, brokerage fees, and other expenses related to the issuance or repurchase of equity instruments.
SIC-17 provides guidance on how to account for such costs incurred in equity transactions. According to SIC-17, costs directly attributable to the acquisition, issue, or disposal of equity instruments should be recognized as a deduction from equity. These costs should not be recognized as an expense in the income statement but should be presented as a reduction in equity in the statement of changes in equity.
Let’s look at some definitions provided by SIC-17:
Costs directly attributable:
These are costs that would not have been incurred if the equity transaction had not taken place. They include costs that are incremental and directly related to the acquisition, issue, or disposal of equity instruments. Examples of such costs include legal fees, registration fees, underwriting fees, and other directly related expenses.
Equity transaction:
This refers to any transaction that involves the issuance, repurchase, or cancellation of equity instruments, including ordinary shares, preferred shares, share options, warrants, or other similar instruments.
Presentation in financial statements:
SIC-17 requires that the costs directly attributable to the equity transaction be presented as a deduction from equity in the statement of changes in equity. These costs should not be recognized as an expense in the income statement.
Now, let’s look at some explanations and examples to better understand the application of SIC-17:
Issuance of Equity Instruments:
When an entity issues equity instruments to raise capital, it incurs costs such as legal fees, underwriting fees, and other expenses. These costs are directly attributable to the issuance of equity instruments and should be recognized as a deduction from equity in the statement of changes in equity. For example, if a company issues 100,000 shares at $10 per share, and the total costs incurred for the issuance of these shares amount to $50,000, then the equity would be recognized as $1,000,000 ($10 per share x 100,000 shares) and the costs would be recognized as a deduction from equity of $50,000, resulting in a net equity of $950,000.
Repurchase of Equity Instruments:
When an entity repurchases its own equity instruments, such as buying back shares from shareholders, it incurs costs such as brokerage fees, legal fees, and other expenses. These costs are directly attributable to the repurchase of equity instruments and should be recognized as a deduction from equity in the statement of changes in equity. For example, if a company repurchases 10,000 shares at $12 per share and the total costs incurred for the repurchase amount to $20,000, then the equity would be recognized as a reduction of $120,000 ($12 per share x 10,000 shares) and the costs would be recognized as a deduction from equity of $20,000, resulting in a net reduction of equity of $100,000.
Cancellation of Equity Instruments: When an entity cancels its own equity instruments, such as when shares are retired or eliminated, it incurs costs such as legal fees, accounting fees, and other expenses. These costs are directly attributable to the cancellation of equity instruments and should be recognized as a deduction from equity in the statement of changes in equity. For example, if a company cancels 5,000 shares with a par value of $1 per share and the total costs incurred for the cancellation amount to $2,500, then the equity would be recognized as a reduction of $5,000 (5,000 shares x $1 per share) and the costs would be recognized as a deduction from equity of $2,500, resulting in a net reduction of equity of $2,500.
It’s important to note that SIC-17 requires that the costs directly attributable to the equity transaction be recognized as a deduction from equity, regardless of whether the equity instruments were issued, repurchased, or canceled at a premium or discount to their nominal value or fair value. Additionally, any transaction costs that are not directly attributable to the acquisition, issue, or disposal of equity instruments, such as general administrative costs or costs incurred for unsuccessful attempts to issue or repurchase equity instruments, should be recognized as expenses in the income statement in the period in which they are incurred.
Now, let’s look at some case studies to further illustrate the application of SIC-17:
Case Study 1:
ABC Corporation is planning to issue 50,000 shares of common stock at $20 per share to raise capital. The total costs incurred for the issuance, including legal fees, underwriting fees, and other expenses, amount to $10,000. How should ABC Corporation account for these costs?
According to SIC-17, the costs directly attributable to the issuance of equity instruments should be recognized as a deduction from equity. In this case, the total costs of $10,000 should be deducted from the equity raised from the issuance of shares. The journal entry to record the issuance of shares and the related costs would be as follows:
Debit: Cash (50,000 shares x $20 per share) $1,000,000
Debit: Costs directly attributable to equity issuance $10,000
Credit: Common stock (50,000 shares x $20 per share) $1,000,000
Credit: Additional paid-in capital $10,000
The costs of $10,000 would be recognized as a deduction from equity in the statement of changes in equity.
Case Study 2:
XYZ Corporation decides to repurchase 20,000 of its own shares in the open market at $15 per share. The total costs incurred for the repurchase, including brokerage fees, legal fees, and other expenses, amount to $5,000. How should XYZ Corporation account for these costs?
According to SIC-17, the costs directly attributable to the repurchase of equity instruments should be recognized as a deduction from equity. In this case, the total costs of $5,000 should be deducted from the equity reduction due to the repurchase of shares. The journal entry to record the share repurchase and the related costs would be as follows:
Debit: Treasury stock (20,000 shares x $15 per share) $300,000
Debit: Costs directly attributable to equity repurchase $5,000
Credit: Cash (20,000 shares x $15 per share) $300,000
The costs of $5,000 would be recognized as a deduction from equity in the statement of changes in equity.
In conclusion, SIC-17 provides guidance on the accounting treatment of costs incurred directly attributable to equity transactions, including issuance, repurchase, and cancellation of equity instruments. These costs should be recognized as a deduction from equity in the statement of changes in equity, regardless of whether the equity instruments were issued, repurchased, or canceled at a premium or discount to their nominal value or fair value. Any costs that are not directly attributable to the equity transaction should be recognized as expenses in the income statement.
Case Study 3:
ABC Corporation is planning to issue 100,000 shares of preferred stock at $50 per share to raise capital. The total costs incurred for the issuance, including legal fees, underwriting fees, and other expenses, amount to $15,000. How should ABC Corporation account for these costs?
According to SIC-17, the costs directly attributable to the issuance of preferred stock should be recognized as a deduction from equity. In this case, the total costs of $15,000 should be deducted from the equity raised from the issuance of preferred stock. The journal entry to record the issuance of preferred stock and the related costs would be as follows:
Debit: Cash (100,000 shares x $50 per share) $5,000,000
Debit: Costs directly attributable to equity issuance $15,000
Credit: Preferred stock (100,000 shares x $50 per share) $5,000,000
Credit: Additional paid-in capital $15,000
The costs of $15,000 would be recognized as a deduction from equity in the statement of changes in equity.
Case Study 4:
XYZ Corporation decides to cancel 10,000 of its own shares with a par value of $2 per share. The total costs incurred for the cancellation, including legal fees, accounting fees, and other expenses, amount to $3,000. How should XYZ Corporation account for these costs?
According to SIC-17, the costs directly attributable to the cancellation of equity instruments should be recognized as a deduction from equity. In this case, the total costs of $3,000 should be deducted from the equity reduction due to the cancellation of shares. The journal entry to record the share cancellation and the related costs would be as follows:
Debit: Common stock (10,000 shares x $2 per share) $20,000
Debit: Costs directly attributable to equity cancellation $3,000
Credit: Treasury stock (10,000 shares x $2 per share) $20,000
The costs of $3,000 would be recognized as a deduction from equity in the statement of changes in equity.
In summary, SIC-17 provides guidance on how to account for the costs of equity transactions, including issuance, repurchase, and cancellation of equity instruments. It requires that costs directly attributable to these transactions be recognized as a deduction from equity in the statement of changes in equity. Companies should carefully review and apply the requirements of SIC-17 to ensure proper accounting treatment of equity transaction costs in their financial statements.