Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and

Financial Liabilities

Solution 23.1

a) Equity instruments are defined as ‘any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities’. IAS 32.11

b) Two classes of shares include: ordinary shares and preference shares.

The main differences between ordinary and preference shares relate to the dividend
entitlement of the shareholders.

The holders of ordinary shares are not guaranteed to receive dividends because ordinary
dividends are dependent on both the profitability of the company and its cash flow.

The holders of preference shares can receive or be owed dividends based on whether the
dividends are discretionary or non-discretionary. If the preference dividend is
discretionary, the dividend is only recognised once it has been declared. If the dividend is
non-discretionary the company has created a liability for all future preference dividends
on the day the preference share is issued.

c) An issue of ordinary shares is recognised by increasing assets (cash) and increasing equity
(share capital). Ordinary dividends declared are recognised as a decrease in equity
(dividends / retained earnings) with a corresponding increase in liabilities (dividends
payable).

d) False:

Although the issue of ordinary shares is always recognised as equity, the issue of
preference shares may be recognised as equity or a liability depending on the
circumstances.

If the preference shares issued are:

- compulsorily redeemable; or
- redeemable at the option of the shareholder; or
- non-redeemable however their dividends are non-discretionary (i.e. mandatory);
then the issue of preference shares will be recognised as a liability and the dividends will
be recognised as a finance cost using the effective interest rate method.

If the preference shares issued are:

- redeemable at the option of the issuer; or
- non-redeemable and their dividends are discretionary;
then the issue of preference shares will be recognised as equity and the dividends will be
recognised as a distribution of equity.

e) True.
When a company issues ‘cumulative preference shares’ it commits itself to the payment
of preference dividends until either the company is wound up or the preference shares are
redeemed. This means that the company creates a present obligation on the date of issue:
a liability equal to all the future preference dividends. The holder of this share is therefore
irrevocably entitled to a distribution every year (or other period specified by the contract).

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.1 continued…

f) False.
The IFRSs do not prevent the issue of par value shares and, in fact, the IFRSs prescribe
how to account for both par value and no-par value shares. However, the national
legislation of certain countries (e.g. South Africa) may prohibit the issue of par value
share whereas the national legislation of other countries (e.g. the UK) may permit the
issue of par value shares.

g) A company could increase the number of its issued shares as set out below, provided that
the share issue is within the limits of its authorised number of shares that it can issue:
• The company could issue shares at market price;
• The company could issue shares to existing shareholders at a price lower than market
price (i.e. a rights issue);
• The company could issue shares to existing shareholders for free by converting
reserves into equity (i.e. a capitalisation issue);
• The company could perform a share split (existing shareholders shares are split into
one or more shares: this does not reflect a transaction of commercial substance from
the entity’s perspective and thus no journal is processed).

h) A share consolidation and a share buy-back both result in fewer issued shares. They both
thereby affect the disclosure of the number of issued shares in the ordinary or preference
share capital notes to the financial statements, and also affect the calculation of the
company’s earnings per share and related disclosure.

A share consolidation involves the conversion of, say two shares into one share, in which
case the number of issued shares will halve. No journal entry is processed for a share
consolidation.

A share buy-back involves a company buying back its own shares: the purchased shares
become what are referred to as treasury shares. These treasury shares are not deemed to be
held by the company, rather, they are deemed to be ‘authorised and unissued’. In other
words, the treasury shares are available to be re-issued.

i) A company satisfies the solvency and liquidity test if:

• The assets of the company, fairly valued, equal or exceed its liabilities, fairly valued;
and
• It appears that the company will be able to pay its debts as they become due in the
ordinary course of business for a period of 12 months after the date on which the test
is considered or in the case of a distribution, 12 months following that distribution. See
Co’s Act section 4

j) Share issue costs (also referred to as transaction costs) must be set-off against the equity
account (e.g. share capital account) unless the issue of shares is abandoned, in which case
the share issue costs will be expensed in profit or loss. See IAS 32.37
Preliminary costs (also called start-up costs) must be expensed in profit or loss. See IAS 38.69

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.2

a) Journals

Debit Credit
2 March 20X4
Legal fees (P/L) Given 10 000
Bank (A) 10 000
Start-up costs (legal fees) expensed
4 March 20X4
Bank (A) 2 000 x 4 x C10 80 000
Ordinary share capital (OE) 80 000
Issue of 2 000 shares to each of the 4 directors at C10 each
Ordinary share capital (OE) Given 1 000
Bank (A) 1 000
Share issue costs set-off against the shares issued
3 June 20X4
Bank (A) 75 000 x C12 900 000
Application account 900 000
Receipt of funds received from applications for shares
5 June 20X4
Application account 900 000
Ordinary share capital (OE) 50 000 x C12 600 000
Bank (A) (75 000 - 50 000) x C12 300 000
Allotment of 50 000 shares and refund of the balance of cash received
5 June 20X4
Ordinary share capital (OE) Given 6 000
Bank (A) 6 000
Share issue costs set-off against the shares issued

b) Disclosure

BABA LIMITED
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 28 FEBRUARY 20X5
Ordinary Retained Total
share earnings
capital
C C C
Opening balance 0 0 0
Ordinary shares issued (80 000 + 600 000) 680 000 680 000
Share issue costs (1 000 + 6 000) (7 000) (7 000)
Total comprehensive income 100 000 100 000
Closing balance 673 000 100 000 773 000

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.3
The Companies Act No. 71 of 2008 (referred to as the Act hereafter) must be considered
before declaring a dividend to the ordinary shareholders. With the purpose of protecting all
parties’ financial interests in a company, section 46 of the Act requires that any distributions
to shareholders (e.g. dividend declarations, redemption of shares and buy-back of shares) may
only be made if:
• The distribution is pursuant to:
- an existing legal obligation of the company, or
- a court order; or
- a resolution by the board of the company authorising the distribution; and
• It appears reasonable that, after the distribution, the company will satisfy the solvency and
liquidity test immediately after completing the proposed distribution; and
• The board of the company, by resolution, has acknowledged that it has applied the
solvency and liquidity test, and concluded that the company will satisfy the solvency and
liquidity test immediately after completing the proposed distribution. Co’s Act S46

Section 4 of the Act states that a company satisfies the solvency and liquidity test if:
• The assets of the company, fairly valued, equal or exceed its liabilities, fairly valued; and
• It appears that the company will be able to pay its debts as they become due in the
ordinary course of business for a period of 12 months after the date on which the test is
considered or, in the case of a distribution, 12 months following that distribution. Co’s Act S4

With respect to Section 4: The solvency and liquidity test

Your trial balance already reflects liabilities that exceed your assets and thus, at first glance, it
would appear that a distribution would not be allowed. However, the Act states that the
assets, fairly valued, must exceed your liabilities, fairly valued, and you did mention that the
fair value of the property, plant and equipment is C1 800 000. This means that the fair value
of your assets (C1 800 000 + C150 000 + C100 000 + C50 000 = C2 100 000) currently
exceeds the fair value of your liabilities (C900 000 + C300 000 + C200 000 = C1 400 000) by
C700 000 ( C2 100 000 – C1 400 000 = C700 000). Thus, as long as the distribution does not
exceed C700 000, then the first part of the solvency and liquidity test will be met.

However, the second part of the solvency and liquidity test requires that Jungle Limited will
be able to pay its debts as they fall due within the 12 months following the distribution. With
this in mind, I draw your attention to your existing situation where you have debts of
C1 400 000 that already currently exceed what appears to be your available resources (I refer
to your current assets of C300 000).

If these debts fall due within the next 12 months, will they be repayable given that your cash
and accounts receivable total only C150 000? If, for instance, the loan is long-term and no
payments are due within the next 12 months, then only your current tax payable and accounts
payable totalling C500 000 would need to be considered. However, the current assets of
C300 000 are not able to repay these current liabilities. You would also need to take into
consideration information that may indicate that further debts will be incurred within the next
12 months in excess of any increase in current assets in the next 12 months. In other words,
you would need to carefully consider whether there is information available to Jungle Limited
that would give you reasonable assurance to be able to prove that Jungle Limited will be able
pay its debts as they become due in the ordinary course of business for a period of 12 months
following the distribution.

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.3 continued ...

With respect to the remaining requirements in Section 46:

Assuming that you are able to prove with reasonable assurance that the solvency and liquidity
test will be satisfied, then, in order not to be in contravention of any other aspect of the Act
you would still need to do the following:
• ensure that you obtain a resolution from the board authorising the distribution; and
• ensure that this same resolution includes a clear statement to the effect that the board has
applied the solvency and liquidity test and concluded that Jungle Limited will satisfy this
test after making the said distribution.

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.4

Scenario 1) Buy-back at market price that equals the average issue price

a) Journal entries

30/6/20X4 Debit Credit

Treasury shares (OE) C3 600/ 1 800 shares = C2 average
1 200
price per share x 600 shares
Bank (A) C2 per share x 600 shares 1 200
Buy-back of 600 shares in terms of s48 – the price paid equals the average
price per share

b) Disclosure

COOLWORTHS LIMITED
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
FOR THE YEAR ENDED 31 DECEMBER 20X4
Ordinary Retained Total
share earnings
capital C C
C
Opening balance 3 600 xxx xxx
Treasury shares (share buy-back) (s48) (1 200) - (1 200)
Total comprehensive income xxx xxx
Closing balance 2 400 xxx xxx

COOLWORTHS LIMITED
NOTES TO THE FINANCIAL STATEMENTS (EXTRACTS)
FOR THE YEAR ENDED 31 DECEMBER 20X4

3. Ordinary share capital

Number of authorised shares: Number

Ordinary shares of no par value 4 200

Number of outstanding shares:

Shares outstanding at the beginning of the year 1 800
Treasury shares (share buy-back) (s48) (600)
Shares outstanding at year-end 1 200

Please note:
The total authorised shares that are available to be issued has now increased by 600 shares to 3 000
shares.
• There were 2 400 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 800); but
• There are now 3 000 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 200).

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.4 continued …

Scenario 2) Buy-back at market price that exceeds the average issue price

a) Journal entries

30/6/20X4 Debit Credit

Treasury shared (OE) C3 600/ 1 800 shares = C2 average price per
1 200
share x 600 shares
Retained earnings Balancing: 600
C1 800 paid – C1 200 average issue price
Bank C3 per share x 600 shares 1 800
Buy-back of 600 shares in terms of s48

b) Disclosure

COOLWORTHS LIMITED
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
FOR THE YEAR ENDED 31 DECEMBER 20X4
Ordinary Retained Total
share earnings
capital C C
C
Opening balance 3 600 xxx xxx
Treasury shares (share buy-back) (s48) (1 200) (600) (1 800)
Total comprehensive income xxx xxx
Closing balance 2 400 xxx xxx

COOLWORTHS LIMITED
NOTES TO THE FINANCIAL STATEMENTS (EXTRACTS)
FOR THE YEAR ENDED 31 DECEMBER 20X4

3. Ordinary share capital

Number of authorised shares: Number

Ordinary shares of no par value 4 200

Number of outstanding shares:

Shares outstanding at the beginning of the year 1 800
Treasury shares (share buy-back) (s48) (600)
Shares outstanding at year-end 1 200

Please note: the total authorised shares that are available to be issued has now increased by 600 shares to
3 000 shares.
• There were 2 400 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 800); but
• There are now 3 000 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 200).

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.4 continued …

Scenario 3) Buy-back at market price that is less than the average issue price

a) Journal entries

30/6/20X4 Debit Credit

Treasury shares (OE) C3 600/ 1 800 shares = C2 average price 1 200
per share x 600 shares
Bank C1 per share x 600 shares 600
Retained earnings Balancing: C1 200 average issue price -
600
C600 paid
Buy-back of 600 shares in terms of s48

b) Disclosure

COOLWORTHS LIMITED
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
FOR THE YEAR ENDED 31 DECEMBER 20X4
Ordinary Retained Total
share earnings
capital C C
C
Opening balance 3 600 xxx xxx
Treasury shares (share buy-back) (s48) (1 200) 600 (600)
Total comprehensive income xxx xxx
Closing balance 2 400 xxx xxx

COOLWORTHS LIMITED
NOTES TO THE FINANCIAL STATEMENTS (EXTRACTS)
FOR THE YEAR ENDED 31 DECEMBER 20X4

3. Ordinary share capital

Number of authorised shares: Number

Ordinary shares of no par value 4 200

Number of outstanding shares:

Shares outstanding at the beginning of the year 1 800
Treasury shares (share buy-back) (s48) (600)
Shares outstanding at year-end 1 200

Please note:
The total authorised shares that are available to be issued has now increased by 600 shares to 3 000
shares.
• There were 2 400 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 800); but
• There are now 3 000 shares available for issue (Authorised: 4 200 – Issued & outstanding: 1 200).

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.5

Journal entries
Debit Credit
1 April 20X5
Bank (A) 250 000
Ordinary share capital (OE) 50 000 x C5 250 000
Rights issue at C5 (market price of C8)

1 December 20X5
Retained earnings (OE) 735 000
Ordinary share capital (OE) 105 000 (W1) x C7 735 000
Capitalisation issue of ordinary shares of 3 shares for every 10 shares
held, at a market price of C7

31 December 20X5
Ordinary share capital (OE) 30 000
Bank (A) 30 000
Share issues costs written off to ordinary share capital

Note: No journal entry occurs on 15 December 20X5 to account for the share split, as
although a share split increases the number of shares issued, there is no change in either the
share capital or the cash resources of Icy Limited

Workings:

W1: Number of shares issued in terms of the capitalisation issue

Actual number
Opening balance 300 000
Rights issue 50 000
350 000
Capitalisation issue 350 000 / 10 x 3 105 000
Closing balance 455 000

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.6

a) Issue of the preference shares

Definitions

Liability:
• a present obligation of the entity
• to transfer an economic resource
• as a result of past events

Equity:
• The residual interest in the assets of the entity after deducting all its liabilities.

Application of the above definitions on the initial issue of preference shares:

Liability:
• Since Perseverance Limited’s preference shares are compulsorily redeemable, the entity
has a present obligation to redeem the preference shares.
• The settlement of this obligation will result in a transfer of economic resources in the
form of cash of C420 000 (in respect of the issue price of the shares: C300 000, the
premium: C30 000 and the annual dividends: C30 000 x 3 years = C90 000).
• The past event is the issue of these shares on 1 January 20X3.

The preference shares therefore meet the definition of a liability.

b) Redemption of the preference shares

Definitions

Expense:
• A decrease in assets, or
• An increase in liabilities
• That result in decreases in equity, other than those relating to distributions to holders of
equity claims.

Application of the above definitions on the redemption of preference shares:

Expense:
• There is a decrease in assets: being the cash outflow of redeeming the preference shares
on 31 December 20X5.
• Resulting in a decrease in equity, other than a distribution to equity participants:
- Since the issue of the preference shares represents a liability, none of the payments to
the preference shareholders represent distributions to equity participants.
- Since the issue price of the shares and premium on redemption are both committed to
on the date that the preference shares are issued and are thus recognised as liabilities,
the repayment of each represents a decrease in assets (decrease in the bank account)
and a decrease in the preference share liability balance, with the result that there is no
impact on the equity. These repayments are therefore not expenses.
- The C300 000 paid is a settlement of the original liability.
- The C30 000 paid is a settlement of the premium that accrued over the 3 years.

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.6 continued . . .

c) Journal entries:

Debit Credit
I January 20X3
Preference share capital (OE) 300 000
Preference share liability (L) 300 000
Recognition of preference shares as a liability

31 December 20X3
Interest expense (E) W1 38 811
Preference share liability (L) 38 811
Preference share liability (L) 30 000
Bank (A) 30 000
Preference dividend recognised as interest expense / premium
accrued and payment of dividend

31 December 20X4
Interest expense (E) W1 39 951
Preference share liability (L) 39 951
Preference share liability (L) 30 000
Bank (A) 30 000
Preference dividend recognised as interest expense / premium
accrued and payment of dividend

31 December 20X4
Preference share liability (non-current liability) W1 318 762
Preference shares (current liability) 318 762
Reclassifying preference shares as a current liability

31 December 20X5
Interest expense (E) W1 41 238
Preference share liability (L) 41 238
Preference share liability (L) 30 000
Bank (A) 30 000
Preference dividend recognised as interest expense / premium
accrued and payment of dividend

31 December 20X5
Preference share liability (L) 330 000
Bank 330 000
Repayment of capital and premium

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.6 continued . . .

Workings

W1: Effective interest table

Interest Premium Preference

Bank
(12,937%) accrued share liability

300 000
31/12/20X3 38 811 (30 000) 8 811 308 811
8 811
31/12/20X4 39 951 (30 000) 9 951 318 762
18 762
31/12/20X5 41 238 (30 000) 11 238 330 000
30 000
31/12/20X5 (330 000) (30 000) 0
120 000 (420 000)

Notes:
• Liabilities should be recognised at the present value of the future cash flows.
• The future cash flows at 31/12/20X4 equal C360 000 (30 000 + 330 000).
• The PV of C360 000 at 12.937% in one year’s time = C318 762 (or per table).

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.7
a) Journal entries

Debit Credit
30 June 20X4
Bank (A) C4 x 90 000 (W1) 360 000
Ordinary share capital (OE) 360 000
Rights issue of 1 ordinary share for every 5 ordinary shares at C4
Preference share capital (OE) 240 000 x C1,50 360 000
Retained earnings (OE) Balancing 18 000
Bank (A) 240 000 x C1,50 x 105% 378 000
Redemption of preference shares at a premium of 5%
Preference dividend (OE) Given 19 200
Bank (A) 19 200
Dividend paid to preference shareholders
30 September 20X4
Retained earnings (OE) C1,50 x 180 000 (W1) 270 000
Ordinary share capital (OE) 270 000
Capitalisation issue of 1 ordinary share for every 3 ordinary shares

b) Statement of changes in equity

GET WELL HOSPITAL LIMITED

STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 20X4
Ordinary
share Preference Retained
capital share capital earnings Total
C C C C
Balance at 1 January 20X4 450 000 360 000 4 592 000 5 402 000
Total comprehensive income 192 000 192 000
Issue of ordinary share capital 360 000 1 360 000
Redemption of preference shares (360 000) (18 000) (378 000)
Capitalisation issue of ordinary shares 270 000 2 (270 000) -
Preference dividend (19 200) (19 200)
Balance at 31 December 20X4 1 080 000 0 4 476 800 5 556 800

1 C4 x 90 000 shares (W1)

2 C1,50 x 180 000 shares (W1)

Workings

W1: Actual number of ordinary shares Number

Opening balance Given 450 000
Rights issue: 30 June 20X4 450 000 / 5 x 1 90 000
540 000
Capitalisation issue: 30 September 20X4 540 000 / 3 x 1 180 000
Closing balance 720 000

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.8

a) Journal entries

Debit Credit
For the year ended 31 March 20X2

1 July 20X1
Bank (A) 400 000 x C1,80 720 000
Ordinary share capital (OE) 720 000
Issue of 400 000 ordinary shares at C1,80
Ordinary share capital (OE) Given 20 000
Bank (A) 20 000
Share issue costs set-off against the shares issued
10 October 20X1
Preference dividend (OE) 200 000 x C4 x 12% 96 000
Bank (A) 96 000
Dividend paid to preference shareholders
For the year ended 31 March 20X3
10 October 20X2
Preference dividend (OE) C800 000 x 12% 96 000
Bank (A) 96 000
Dividend paid to preference shareholders
31 December 20X2
Retained earnings C1 x (2 000 000 + 400 000)/ 4 600 000
Ordinary share capital (OE) shares x 1 share 600 000
Capitalisation issue of 1 ordinary share for every 4 ordinary shares
28 February 20X3
Ordinary dividend (equity distrib) C0,05 x (2 000 000 + 400 000 + 150 000
Dividends payable (L) 600 000 shares) 150 000
Dividend declared to ordinary shareholders

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.8 continued ...

b) Statement of changes in equity

LION LIMITED
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 MARCH 20X3
Ordinary Preference
share share Revaluation Retained
capital capital surplus earnings Total
C C C C C
Balance at 31 March 20X1 1 800 000 800 000 300 000 10 000 000 12 900 000
Share issue on 1 July 20X1 720 000 - - - 720 000
Share issue expenses (20 000) - - - (20 000)
Total comprehensive income - - - 900 000 900 000
Preference dividend declared - - - (96 000) 3 (96 000)
Balance at 31 March 20X2 2 500 000 800 000 300 000 10 804 000 14 404 000
Capitalisation issue 600 000 1 - - (600 000) -
Total comprehensive income - - 110 000 1 500 000 1 610 000
Ordinary dividend declared - - - (150 000) 2 (150 000)
Preference dividend declared - - - (96 000) 3 (96 000)
Balance at 31 March 20X3 3 100 000 800 000 410 000 11 458 000 15 768 000

Workings:
1 C1 x (2 000 000 + 400 000)/ 4 shares
2 C0,05 x 3 000 000 shares
3 12% x C800 000

c) Share capital note

LION LIMITED
NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31 MARCH 20X3

5. Ordinary and preference share capital note

Authorised
5 000 000 ordinary shares of no par value.
200 000 12% non-cumulative preference shares of no par value.

Issued
3 000 000 ordinary shares of no par value
200 000 12% non-cumulative preference shares of no par value

Reconciliation of number of shares

Ordinary Preference
Balance outstanding at 01 April 20X1 2 000 000 200 000
Share issue on 1 July 20X1 400 000 -
Balance at 31 March 20X2 2 400 000 200 000
Capitalisation issue on 31 December 20X2 (2 400 000/4) 600 000 -
Balance outstanding at 31 March 20X3 3 000 000 200 000

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.9

Journal entries
Debit Credit
31 December 20X5
Interest expense (P&L) 12 140
Preference share liability (non-current liability) W3 2 140
Preference share liability (current liability) 10 000
Dividend for the year & premium accrued

Preference share liability (non-current liability) 110 000

Preference share liability (current liability) 110 000
Shares redeemable at a premium of C0,20 per share

Bank (A) 24 000

Ordinary share capital (OE) 24 000
Ordinary shares issued to finance redemption

Bank (A) 96 000

10% Debentures liability (non-current liability) 96 000
10% Debentures issued: 9 600 x C10 each (W1)

Preference share liability (current liability) 120 000

Bank (A) 120 000
Paid preference shareholders amount due (capital plus dividend)

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.9 continued . . .

Workings

W1 Financing

Cash needed Capital: 50 000 x C2,20 + Dividend: 50 000 x C2 x 10% 120 000

Cash resources from:

- Fresh issue of ordinary shares 24 000
- Fresh issue of debentures required Balancing 96 000
120 000

W2 Cash flow

Inflow/ (outflow) Calculations

1/1/X0 100 000
31/12/X0 (10 000) 50 000 x C2 x 10%
31/12/X1 (10 000) 50 000 x C2 x 10%
31/12/X2 (10 000) 50 000 x C2 x 10%
31/12/X3 (10 000) 50 000 x C2 x 10%
31/12/X4 (10 000) 50 000 x C2 x 10%
31/12/X5 (120 000) 50 000 x C2 x 10% + 50 000 x C2.20

The effective interest rate is 11.25563551% (using a financial calculator).

W3 Preference shares

Premium
Interest Dividend Premium balance PV
1/1/X0 100 000
31/12/X0 11 256 (10 000) 1 256 1 256 101 256
31/12/X1 11 397 (10 000) 1 397 2 653 102 653
31/12/X2 11 554 (10 000) 1 554 4 207 104 207
31/12/X3 11 729 (10 000) 1 729 5 936 105 936
31/12/X4 11 924 (10 000) 1 924 7 860 107 860
31/12/X5 12 140 (10 000) 2 140 10 000 110 000
70 000 60 000

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.10

a) Statement of changes in equity

DPD LIMITED
EXTRACT FROM STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 20X6
Ordinary share Retained
capital earnings Total
C C C
Balance 1/01/X6 1 000 000 287 500 1 287 500
Ordinary shares issued during year 331 250 331 250
Share issue expenses (22 500) (22 500)
Total comprehensive income 126 700 126 700
Balance 31/12/X6 1 308 750 414 200 1 722 950

b) Statement of financial position

DPD LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER 20X6
20X6 20X5
EQUITY AND LIABILITIES Note C C
Capital and reserves
Ordinary share capital 4 1 308 750 1 000 000
Retained earnings 411 750 287 500

Non-current liabilities
Debentures W1 62 500 0

Current liabilities
12% Redeemable preference shares W4 5 - 389 050
Bank overdraft (75K + 22,5K + 45K) 142 500 xxx
Current tax payable: income tax 71 050 xxx

© Service & Kolitz, 2022 - 2023 Chapter 23: Page 18

Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.10 continued . . .

c) Notes

DPD LIMITED
FROM NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31 DECEMBER 20X6

3. Accounting policies

3.5 Preference shares

Preference shares, which are redeemable at the option of the shareholder, are presented as long-term
liabilities, as they are in substance borrowings. The dividends on such preference shares are recognised
in the statement of comprehensive income as interest expense on the effective interest rate basis.

4. Ordinary share capital

Authorised Quantity

Ordinary shares of no par value 2 500 000

Issued Quantity

Number of shares in issue at the beginning of the year 1 000 000

Number of shares issued during the year 265 000
Number of shares in issue at the end of the year 1 265 000

5. Redeemable preference shares

Authorised Quantity

12% redeemable preference shares of no par value 250 000

Issued Quantity

Number of shares in issue at the beginning of the year 187 500

Shares redeemed during the year (187 500)
Number of shares in issue at the end of the year -

The preference shares were redeemed, at the option of the shareholders, on 31 December 20X6 at a
premium of C0,10 per share. The 12% preference dividends are cumulative and non-discretionary.
The effective interest rate is 12,7750262%.

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Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.10 continued . . .

Workings

W1: Cash required from issue of ordinary shares

C
Redemption of 187 500 12% preference shares at C2,00 each 375 000
Premium of C0,10 per share 18 750
393 750
Debenture issue 250 x C250 (62 500)
Cash required from issues of shares 331 250

C331 250
 Number of shares to be issued = 265 000 shares
C1,25
Note: the issue expenses and preference dividends will be financed by utilising the bank overdraft.

W2: T-accounts

ORDINARY SHARE CAPITAL

Description C Description C
Bank 22 500 Balance 1 000 000
Bank 331 250
Balance 1 308 750
1 331 250 1 331 250
Balance 1 308 750

RETAINED EARNINGS
Description C Description C
Balance 287 500
Profit and loss (W3) 126 700
Balance 414 200
414 200 414 200
Balance 414 200

W3: Profit for the period ended 31 December 20X6

Sales 740 000

Cost of sales (300 000)
Operating expenses (200 000)
Interest income 5 000
Profit before finance charges and tax 245 000
Finance charges W4 (49 700)
Profit before tax 195 300
Tax expense W5 (68 600)
Profit for the year 126 700
Other comprehensive income Given 0
Total comprehensive income for the year 126 700

© Service & Kolitz, 2022 - 2023 Chapter 23: Page 20

Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.10 continued . . .

W4: Preference shares

Cash flow schedule

1/1/X2 375 000
31/12/X2 (45 000)
31/12/X3 (45 000)
31/12/X4 (45 000)
31/12/X5 (45 000)
31/12/X6 (438 750) (393 750 + 45 000)

Use a financial calculator to compute the internal rate of return (IRR). = 12,775%) (See W6)

Interest Premium
12,775% Dividend Premium balance PV
1/1/X2 375 000
31/12/X2 47 907 (45 000) 2 907 2 907 377 907
31/12/X3 48 278 (45 000) 3 278 6 185 381 185
31/12/X4 48 696 (45 000) 3 696 9 881 384 881
31/12/X5 49 169 (45 000) 4 169 14 050 389 050
31/12/X6 49 700 (45 000) 4 700 18 750 393 750
243 750 (225 000)

W5: Tax calculation

Profit before tax 195 300

Add back: Finance charge (not deductible) 49 700
Taxable profit 245 000

Tax at 29% (245 000 x 2289%) 68 600

W6: Calculation of internal rate of return (IRR)

Present value (PV) 375 000

Payment (PMT) -45 000
Future value (FV) -393 750
Number of periods (n) 5
Compute interest (comp i) 12,775%

© Service & Kolitz, 2022 - 2023 Chapter 23: Page 21

Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.11

TANDOORI LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION
AT 30 JUNE 20X5
20X5 20X4
Note C C
EQUITY & LIABILITIES
Capital and reserves
Ordinary share capital (215 000 + 73 600) 2 288 600 215 000
Preference share capital - 100 000
Retained earnings (60 000 + 80 000– 3 000) 137 000 60 000

Non-current liabilities
Debentures 3 29 400 -

TANDOORI LIMITED
EXTRACT FROM STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 30 JUNE 20X5
Ordinary Preference
share share Retained
capital capital earnings Total
C C C C
Balance 30/6/X4 215 000 100 000 60 000 375 000
Total comprehensive income 80 000 80 000
Shares issued during
the year 73 600 - - 73 600
Preference shares redeemed (100 000) - (100 000)
Premium on redemption written off - - (3 000) (3 000)
Balance 30/6/X5 288 600 - 137 000 425 600

© Service & Kolitz, 2022 - 2023 Chapter 23: Page 22

Solutions to GAAP : Graded Questions Share Capital: Equity Instruments and
Financial Liabilities

Solution 23.11 continued . . .

TANDOORI LIMITED
NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30 JUNE 20X5

2. Share capital

Authorised
300 000 ordinary shares of no par value
100 000 16% preference shares of no par value

Issued
Ordinary Preference
Qty Qty
Number of shares in issue at beginning of year 200 000 100 000
Issued during the year (W1) 58 880
Redeemed during the year (100 000)
Number of shares in issue at end of year 258 880 -

3. Debentures
C
30 000 debentures of C1 each 30 000
Debenture discount unamortised (600)
29 400

Workings

W1 Financing C
Cash needed (C100 000 +C 3 000) 103 000

Cash resources
- Debentures (C30 000 x 0,98) 29 400
- Fresh issue required (C103 000 – C29 400) 73 600
103 000

Issue price 1.25

Number of shares issues (73 600 / C1,25) 58 880

© Service & Kolitz, 2022 - 2023 Chapter 23: Page 23