Capital Structure and Finance Costs

Objective A-D: Capital Structure and Equity

The capital structure of a limited liability company describes how the company is financed. It typically includes:

Share Capital

• Ordinary shares: The most common type. Ordinary shareholders are the owners of the company. They have voting rights, receive dividends (at the directors' discretion), and bear the highest risk.
• Preference shares: These carry a fixed dividend rate and are paid before ordinary shareholders. They may be redeemable (the company can buy them back) or irredeemable. Redeemable preference shares are classified as liabilities under IFRS because they create an obligation to transfer economic resources.

Borrowings

Loans, debentures, and other debt instruments. Interest on borrowings is a finance cost in the SPL.

Components of Equity

When shares are issued at a premium:

• Dr Cash (total proceeds)
• Cr Share Capital (nominal value)
• Cr Share Premium (excess over nominal value)

Example: 10,000 shares with nominal value £1 issued at £3 each:
Dr Cash £30,000 | Cr Share Capital £10,000 | Cr Share Premium £20,000

Objective E-H: Bonus Shares and Rights Issues

Bonus Shares

A bonus issue (also called a scrip issue or capitalisation issue) gives existing shareholders additional shares for free, in proportion to their existing holdings. No new cash is raised — the issue is funded by transferring reserves (usually share premium or retained earnings) to share capital.

Advantages: Makes shares more affordable (lower price per share), signals confidence, rewards shareholders.
Disadvantages: No new cash raised, dilutes earnings per share, administrative costs.

Journal entry for a bonus issue funded from share premium:
Dr Share Premium | Cr Share Capital

Rights Issue

A rights issue offers existing shareholders the right to buy additional shares at a discounted price, in proportion to their existing holdings. This DOES raise new cash.

Advantages: Raises new capital, existing shareholders maintain proportional ownership, lower issue costs than a public offering.
Disadvantages: Shareholders must invest more money, share price may fall to reflect dilution.

Journal entry: Same as a normal share issue — Dr Cash | Cr Share Capital | Cr Share Premium

Objective I-K: Dividends, Interest, and the SOCIE

Dividends

Dividends are distributions of profit to shareholders. They are NOT expenses — they are deducted from retained earnings in the statement of changes in equity.

When dividends are declared: Dr Retained Earnings | Cr Dividends Payable (liability)
When dividends are paid: Dr Dividends Payable | Cr Cash

Interest Expenses

Interest on borrowings IS an expense — it is a finance cost recognised in the statement of profit or loss.

Dr Finance Costs (SPL) | Cr Cash (or Interest Payable if accrued)

Statement of Changes in Equity (SOCIE)

The SOCIE reconciles opening to closing equity, showing:

• Profit for the year
• Other comprehensive income (e.g., revaluation gains)
• Dividends paid
• Share issues (including bonus and rights issues)
• Any other movements in equity