Capital Structure and Finance Costs for ACCA Financial Accounting

What this chapter covers

Capital structure and finance costs: topics in the order to study them

1. 1Share Capital: Ordinary and Preference SharesStart here because every later topic uses these terms: nominal value, ordinary shares, preference shares and how each is classified.
2. 2Issue of Shares: Par Value and Share PremiumNext, learn the basic double entry for an issue, splitting proceeds between share capital and share premium.
3. 3Bonus Issues and Rights IssuesThese build on share issues. You need to know which one brings in cash and which uses reserves.
4. 4Reserves and Statement of Changes in EquityOnce you know how share capital and premium arise, you can see all equity movements together in one statement.
5. 5Dividends and Their Accounting TreatmentDividends reduce retained earnings and link to the statement of changes in equity, so study them after reserves.
6. 6Loan Notes, Debentures and Finance CostsFinish with debt finance, so you can compare it with equity and handle interest, accruals and effective rate questions.

How to prepare Capital structure and finance costs

1. Write one line defining each term: nominal value, share premium, bonus issue, rights issue, retained earnings, loan note.
2. Learn the journal for each transaction and say what each debit and credit does to the statement of financial position.
3. Practise share issue questions until you split proceeds into nominal value and premium without hesitation.
4. Draw a blank statement of changes in equity with columns for share capital, share premium, other reserves and retained earnings, and fill it from short scenarios.
5. Calculate dividends and finance costs, then decide whether each belongs in equity, the statement of profit or loss, or liabilities.
6. Do timed objective test questions for each topic, then review every wrong answer and name the rule you missed.
7. Finish with a full company accounts question, checking that the equity and loan note figures agree with your workings.

Common mistakes in Capital structure and finance costs

• Recording the full issue price as share capital

  Fix: Always split the proceeds: nominal value to share capital, the excess to share premium.

• Treating a bonus issue as bringing in cash

  Fix: Remember a bonus issue is a transfer between equity accounts. Debit a reserve and credit share capital.

• Putting dividends through profit or loss

  Fix: Equity dividends go to the statement of changes in equity. Only finance costs, such as loan note interest, go to profit or loss.

• Calculating loan interest on the wrong amount or period

  Fix: Use nominal value × rate × months outstanding ÷ 12, then compare it with the interest already paid to find the accrual.

• Declaring a dividend that was proposed after the year end as a liability

  Fix: Check the date. If the dividend was not declared by the reporting date, do not recognise it in that year's accounts.

• Choosing too many or too few options in multiple response questions

  Fix: Read how many answers are required first. Eliminate wrong options, then select exactly that number.

Last-day revision: Capital structure and finance costs

• ✓Share capital is recorded at nominal value, not at the issue price.
• ✓Share premium = issue price − nominal value, multiplied by the number of shares.
• ✓Share premium is a reserve, not part of share capital.
• ✓A bonus issue moves reserves into share capital and brings in no cash.
• ✓A rights issue offers shares to existing shareholders, usually below market price, and brings in cash.
• ✓Ordinary dividends are recognised when declared, not when proposed after the year end.
• ✓Dividends are shown in the statement of changes in equity, not in profit or loss.
• ✓Redeemable preference shares are normally classed as liabilities, and their dividends are finance costs.
• ✓Loan note interest is a finance cost in profit or loss, accrued if unpaid at the year end.
• ✓Interest = loan amount × coupon rate, based on the nominal value of the loan.
• ✓Equity items in the statement of changes in equity must agree to the statement of financial position.
• ✓In multiple response questions, select exactly the stated number of options.

Capital structure and finance costs practice questions

• Kora Co has 800,000 $0.50 equity shares in issue. It makes a 1 for 5 rights issue at $1.20 per share and all rights are taken up. Issue cost…
• On 1 January 20X5 Tarn Co issued $1,000,000 of 4% loan notes at par, incurring issue costs of $40,000. The loan notes are redeemable at par …
• Cedar Co issues 300,000 $1 ordinary shares at $1.60 each. Issue costs of $12,000 are paid in cash and, under IFRS, are a direct cost of the …
• Birch Co has 500,000 $0.50 ordinary shares in issue and a share premium balance of $40,000. It makes a 1 for 5 bonus issue, using the share …
• Jarrow Co issues 200,000 $1 ordinary shares at $1.60 each, fully paid in cash. Which journal entry is correct?
• Dunmore Co issued $500,000 of 6% loan notes on 1 October 20X4. Interest is paid half-yearly in arrears on 31 March and 30 September. The yea…
• Ostrava Ltd has 3,000,000 equity shares of $1 each and 1,000,000 8% redeemable preference shares of $1 each, correctly classified as liabili…
• Pellam Co has the following extracts: profit before interest and tax $360,000; finance costs $40,000; equity $900,000; non-current liabiliti…

Capital structure and finance costs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

• CS ProfessionalSources of Corporate Funding
• CA IntermediateCost of Capital
• ACCA Applied SkillsGains and losses on the disposal of shares and securities
• ACCA Strategic ProfessionalCapital gains tax: gains and losses on the disposal of shares and securities