ACCA Applied Knowledge · Financial Accounting · Capital structure and finance costs
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 premium account first and then retained earnings as needed. What is the effect on retained earnings?
Retained earnings fall by $10,000. The bonus issue creates 100,000 new shares at $0.50, so share capital rises by $50,000. Share premium of $40,000 absorbs part of this, and the remaining $10,000 is taken from retained earnings, with no cash involved.
- ADecrease of $25,000
- BDecrease of $10,000Correct
- CDecrease of $50,000
- DNo effect
Explanation
New shares are 500,000 / 5 = 100,000 at $0.50 = $50,000 credited to share capital. Share premium of $40,000 is used first, leaving $10,000 to be taken from retained earnings. The $25,000 option wrongly uses half the amount, and 'no effect' wrongly assumes premium covers it all.
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