Thompson Ltd has the following capital structure at 31 December 2024. $ Ordinary share capital (300 000 shares of $1 each) 300 000 Share premium 45 000 8% d...
Question 1 Report
Thompson Ltd has the following capital structure at 31 December 2024.
| $ | |
|---|---|
| Ordinary share capital (300 000 shares of $1 each) | 300 000 |
| Share premium | 45 000 |
| 8% debentures (repayable 2030) | 200 000 |
| General reserve | 80 000 |
| Retained earnings | 65 000 |
During the year, debenture interest of $8 000 was paid on 30 June 2024. No further interest has been recorded.
(a) State what is meant by a debenture. [2]
(b) Calculate the total debenture interest for the year. [2]
(c) Calculate the debenture interest owing at 31 December 2024. [2]
(d) Show the journal entry to record the debenture interest owing. [3]
(e) State where each of the following would appear in the statement of financial position:
| Item | Classification |
|---|---|
| 8% debentures | |
| Debenture interest owing | |
| Share premium | |
| General reserve |
[4]
(f) Explain two differences between raising finance by issuing shares and by issuing debentures. [4]
(g) Give one advantage to a company of using debentures rather than issuing more shares. [3]
Answer Details
(a) Meaning of a debenture
A debenture is a long-term loan made to a company, typically secured against the company's assets. [1]
It carries a fixed rate of interest (8% in this case) and has a specified repayment date (2030). The interest must be paid regardless of whether the company makes a profit. [1]
(b) Total debenture interest for the year
\( 8\% \times \$200\,000 = \$16\,000 \) [1] [1]
The full year's interest charge is calculated by applying the debenture rate to the face value of the debentures.
(c) Debenture interest owing at 31 December 2024
Total interest for the year: $16,000
Amount already paid (30 June 2024): $8,000
\( \text{Interest owing} = \$16\,000 - \$8\,000 = \$8\,000 \) [1] [1]
The $8,000 represents the second half-year's interest that has accrued but has not yet been paid.
(d) Journal entry to record the debenture interest owing
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Debenture interest | 8 000 [1] | |
| Debenture interest owing / Accrued expenses | 8 000 [1] |
Narration: Debenture interest accrued for the half year to 31 December 2024. [1]
The debit to debenture interest records the expense in the income statement. The credit creates a current liability representing the amount owed.
(e) Classification in the statement of financial position
| Item | Classification |
|---|---|
| 8% debentures | Non-current liabilities [1] |
| Debenture interest owing | Current liabilities [1] |
| Share premium | Equity (shareholders' funds) [1] |
| General reserve | Equity (shareholders' funds) [1] |
Debentures are non-current liabilities because they are not due for repayment until 2030. Interest owing is a current liability because it is due for payment in the short term. Share premium and general reserve both form part of equity.
(f) Two differences between raising finance by issuing shares and by issuing debentures
Difference 1: Shares give ownership rights in the company, including voting rights and a share of profits. [1] Debentures do not give ownership; the debenture holder is a creditor, not an owner. [1]
Difference 2: Debenture interest must be paid regardless of whether the company makes a profit, because it is a legal obligation. [1] Share dividends are only paid if the company has sufficient profits and the directors choose to declare them. [1]
(g) One advantage of using debentures rather than issuing more shares
The existing shareholders' ownership and control of the company is not diluted. [1] Issuing more shares would reduce each existing shareholder's percentage ownership and voting power. [1] Additionally, debenture interest is a business expense that reduces taxable profit, whereas dividends are paid from after-tax profit. [1]
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