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ACCA Applied Knowledge · Financial Accounting · Capital structure and finance costs

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 liabilities. For the year, profit before preference dividend and tax is $900,000, tax is $200,000, and the preference dividend of $80,000 has been paid in cash. An equity dividend of $0.10 per share was also paid. Opening retained earnings were $500,000. What is the closing retained earnings balance?

Closing retained earnings are $820,000. The redeemable preference dividend is a finance cost, so profit for the year is 900,000 less 80,000 less 200,000 tax, which is $620,000. Deducting the $300,000 equity dividend and adding the $500,000 opening balance gives $820,000.

  1. A$820,000Correct
  2. B$900,000
  3. C$720,000
  4. D$1,020,000

Explanation

The preference dividend on liability-classified shares is a finance cost, so profit before the $80,000 finance cost of $900,000 becomes $820,000 before tax. The wording says profit before preference dividend and tax is $900,000, so: 900,000 - 80,000 - 200,000 = 620,000 profit for the year. Less equity dividend 300,000 gives 320,000; add opening 500,000 = 820,000. Treating the preference dividend as a distribution as well would double count it and give $740,000 or similar; omitting the finance cost gives $900,000.

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