Fernandez Ltd has the following equity information at 30 September 2024. $ Ordinary share capital (400 000 shares of $1 each) 400 000 Share premium 50 000 G...
Question 1 Report
Fernandez Ltd has the following equity information at 30 September 2024.
| $ | |
|---|---|
| Ordinary share capital (400 000 shares of $1 each) | 400 000 |
| Share premium | 50 000 |
| General reserve | 120 000 |
The market price of each ordinary share is $1.80.
The directors are considering two options to raise finance or reward shareholders:
Option 1: A rights issue of 1 new share for every 4 held at a price of $1.40 per share.
Option 2: A bonus issue of 1 new share for every 5 held, using the general reserve.
(a) State what is meant by a rights issue. [2]
(b) For Option 1, calculate:
(i) the number of new shares to be issued [1]
(ii) the total cash received by the company [2]
(iii) the amount to be credited to the share premium account [2]
(c) For Option 2, calculate the number of bonus shares to be issued. [1]
(d) Show the journal entry to record the bonus issue in Option 2. [4]
(e) State what is meant by a bonus issue. [2]
(f) Explain two differences between a rights issue and a bonus issue. [6]
Answer Details
(a) Meaning of a rights issue
A rights issue is an issue of new shares offered to existing shareholders. [1]
The shares are offered in proportion to each shareholder's existing holding (for example, 1 for every 4 held) and at a price below the current market price to encourage take-up. [1]
(b) Calculations for Option 1 (rights issue)
(i) Number of new shares to be issued:
\( \frac{400\,000}{4} = 100\,000 \text{ new shares} \) [1]
(ii) Total cash received by the company:
\( 100\,000 \times \$1.40 = \$140\,000 \) [1] [1]
Each of the 100,000 new shares is issued at $1.40, so the company receives $140,000 in total.
(iii) Amount to be credited to the share premium account:
The nominal value per share is $1.00. The issue price is $1.40. The premium per share is:
\( \$1.40 - \$1.00 = \$0.40 \text{ per share} \) [1]
Total share premium: \( 100\,000 \times \$0.40 = \$40\,000 \) [1]
Of the $140,000 received, $100,000 is credited to ordinary share capital (100,000 shares at $1 nominal value) and $40,000 is credited to the share premium account.
(c) Number of bonus shares for Option 2
\( \frac{400\,000}{5} = 80\,000 \text{ bonus shares} \) [1]
(d) Journal entry for the bonus issue (Option 2)
| Account | Debit ($) | Credit ($) |
|---|---|---|
| General reserve | 80 000 [1] [1] | |
| Ordinary share capital | 80 000 [1] |
Narration: Bonus issue of 80,000 ordinary shares of $1 each, funded from general reserve. [1]
The general reserve is reduced (debited) because its balance is being capitalised (converted into permanent share capital). The ordinary share capital increases (credited) by the nominal value of the new shares issued.
(e) Meaning of a bonus issue
A bonus issue is an issue of free shares to existing shareholders in proportion to their existing holdings. [1]
It is made by capitalising reserves (converting reserves into share capital). No cash is received by the company. [1]
(f) Two differences between a rights issue and a bonus issue
Difference 1: A rights issue raises new capital (cash) for the company, [1] while a bonus issue does not raise any cash because the shares are issued free of charge. [1]
Difference 2: In a rights issue, shareholders must pay for the new shares at the issue price, [1] while in a bonus issue, the shares are distributed at no cost and are funded by transferring existing reserves to share capital. [1]
Difference 3: A rights issue increases the total equity of the company by the amount of cash received, [1] while a bonus issue does not change total equity because it merely reclassifies reserves as share capital within equity. [1]
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