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

Tarn Co has 2,000,000 ordinary shares of $1 each. It has 500,000 $1 5% redeemable preference shares classified as a liability. What is the correct accounting for the annual preference dividend of $25,000?

Debit finance costs and credit cash with $25,000. Because the redeemable preference shares are classified as a liability, their dividend is treated as a finance cost in profit or loss, not as a distribution from retained earnings.

  1. ADebit retained earnings $25,000, credit cash $25,000
  2. BDebit finance costs $25,000, credit cash $25,000Correct
  3. CDebit share capital $25,000, credit cash $25,000
  4. DDebit share premium $25,000, credit cash $25,000

Explanation

Redeemable preference shares are liabilities under IAS 32, so their dividends are treated as interest and charged to profit or loss as finance costs. Debiting retained earnings would be correct only for equity-classified shares.

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