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The following sections discuss notes received for common stock, advances to shareholders, and distributions of shares in settlement of litigation. See FG 8.4 for information on shareholder rights plans.

4.5.1 Notes received for common stock

When a reporting entity receives a note, rather than cash or other assets, in exchange for common shares or as a contribution to paid-in capital, the note should generally be recognized in equity as an offset to the shares issued. As discussed in ASC 505-10-45-2, recording the note as an asset is generally not appropriate except in very limited circumstances when there is substantial evidence of an intent and ability to pay the note in a reasonably short period of time.
As discussed in ASC 310-10-S99-2, the SEC staff believes public companies should record notes received in exchange for common stock as contra-equity (rather than an asset) unless the note is paid prior to the issuance of the financial statements. For private companies, in addition to a stated maturity occurring within a short time period, notes secured by irrevocable letters of credit or other liquid collateral can evidence an intent and ability to pay a note in a reasonably short period.
See FSP 5.10.1 for information on the presentation of notes received for common stock.

4.5.2 Advances to, and receivables from, shareholders

For public companies, ASC 310-10-S99-3 requires that notes or other receivables from a parent or another affiliate be recorded as contra-equity. The SEC staff indicated that the balance sheet display of these or similar items is not determined by the quality or actual value of the receivable or other asset contributed, but by the relationship of the parties and the control inherent in that relationship. Although ASC 310-10-S99-3 discusses this guidance in the context of a partnership, we believe this guidance is applicable to other types of public companies as well.

4.5.2.1 Guidance for private companies

Other than ASC 505-10-45-2 (discussed in FG 4.5.1), there is no authoritative guidance that deals directly with advances to, and receivables from, shareholders of private companies. With the limited guidance, we believe the decision to reflect an advance to, or receivable from, a shareholder as an asset or, alternatively, as a reduction of shareholders’ equity, is dependent upon the specific facts of each situation. Generally, advances to, or receivables from, shareholders should be recognized as a reduction of equity. However, as discussed in ASC 505-10-45-2, there may be some circumstances in which it is acceptable to classify the advance or receivable as an asset. A reporting entity should consider the following factors when determining the appropriate classification.
• The nature of the advance and the circumstances giving rise to the transaction
In general, asset classification is only appropriate when an advance to, or receivable from, a shareholder is short-term and results from the normal course of business.
• Whether the receivable has fixed repayment terms and whether it is interest-bearing or collateralized
• The frequency of such advances and prior repayment histories
Question FG 4-1 discusses how a reporting entity should classify equal advances made to shareholders.
Question FG 4-1
Five shareholders each own 20% of a reporting entity. All five shareholders receive advances in the same amount with no interest or repayment terms. How should the reporting entity account for the advances?
PwC response
The reporting entity should account for the advances as a dividend because they are made to all shareholders and do not provide for repayment or the payment of interest.
If, on the other hand, not all of the shareholders received advances, the reporting entity would account for the advances as a reduction of shareholders’ equity.

Question FG 4-2 discusses how a subsidiary should classify periodic advances to its parent when the parent has no means to repay the subsidiary.
Question FG 4-2
The parent receives periodic advances from a subsidiary to fund its debt service and has no means to repay the subsidiary. How should the subsidiary classify the advances to its parent in its separate financial statements?
PwC response
The subsidiary should classify the advances to its parent as a reduction of shareholder’s equity or a dividend, not as an asset, in its separate financial statements.

Question FG 4-3 discusses how subsidiaries classify advances to their parent when the parent historically repaid the advances.
Question FG 4-3
A corporate conglomerate with numerous operating subsidiaries obtains advances from its subsidiaries as an alternative to bank financing. Historically, the parent has repaid the advances. How should the subsidiaries classify the advances to their parent in their separate financial statements?
PwC response
If the historical and current operations support the parent’s ability and intent to repay the advances, the subsidiaries may classify the advances to their parent as assets in their separate financial statements.

Question FG 4-4 discusses how a subsidiary should classify receivables from its parent when the subsidiary sells substantially all of its manufactured goods to the parent and recoverability of intercompany receivables has not historically been an issue.
Question FG 4-4
A subsidiary sells substantially all of its manufactured goods to its parent. Intercompany receivables are settled periodically and historically, recoverability has not been an issue. How should the subsidiary classify the receivable from its parent in its separate financial statements?
PwC response
The subsidiary may classify the receivables from its parent as an asset in its separate financial statements.

Question FG 4-5 discusses how a reporting entity should classify advances made to a shareholder who has failed to repay advances in the past.
Question FG 4-5
A reporting entity makes an advance to a shareholder to whom it has a history of making advances. The shareholder has failed to repay advances in the past and the reporting entity has forgiven the indebtedness. How should the reporting entity classify the advance?
PwC response
The reporting entity should account for the advance as a reduction of shareholders’ equity because the reporting entity’s history with the shareholder leaves repayment of the advance in doubt.

Regardless of whether the advance to or receivable from the shareholder is recorded as an asset or in equity, a reporting entity should consider the disclosure requirements of ASC 850, Related Party Disclosures. See FSP 26 for information on disclosure of related party transactions.

4.5.2.2 Accounting for interest on shareholder loans

There is no specific guidance on the accounting for interest on shareholder loans. We believe a reporting entity may either recognize the interest as a capital contribution upon receipt, or accrue interest income as earned. We believe recognizing a capital contribution as interest is received is generally the more appropriate treatment unless the note receivable is classified as an asset; in that case, accruing interest income when it is earned would be appropriate.

4.5.3 Stock issued to shareholders in settlement of litigation

A pro rata distribution of common stock to all current shareholders in connection with a litigation settlement can be accounted for as either a stock dividend or stock split rather than as an expense associated with the litigation settlement. If, however, the common stock is distributed only to shareholders of record during the class action period (class action shareholders), the fair value of the shares distributed should be expensed as a litigation settlement. Similarly, if all current shareholders receive a pro rata distribution and the class action shareholders receive an additional distribution, the fair value of the additional shares distributed to class action shareholders should be expensed as a litigation settlement. The shares distributed on a pro rata basis to all current shareholders may be treated as a stock dividend or stock split.
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