Pre-Mock Exam 2012-2013 (Issue of shares and debentures) 2. Sea Limited had an authorized share capital of $500,000, divided into 200,000 ordinary shares of $2 each and 50,000 6% preference shares of $2 each and issued share capital consisting of 150,000 ordinary shares of $2 each and all preference shares of $2 each as at 1 April 2010. An inexperienced accounting clerk drafted an income statement as follows:

Sea Limited Income statement for the year ended 31 March 2011 $ $ Gross profit 869,000 Less: Expenses Administrative expenses 590,000 Debenture interest 39,200 629,200 Net profit 239,800 Add: Retained profit b/f 150,000 389,800 Less: Appropriations Ordinary share dividend – interim 30,000 – final 5,000 35,000 Retained profits c/f 354,800

Additional information: (i) Sea limited paid rent and rates of $5,600 which covered the period from 1 January 2011 to 31 March 2012. (ii) On 1 September 2010, Sea Limited issued the remaining ordinary shares at $4 each. It also paid an interim dividend of $0.05 per ordinary share. (iii) On 1 April 2010, Sea Limited issued 8% debenture of $500,000 at 98 to raise capital. Interest was payable on 30 September each year. The discount on debentures was to be written off evenly over five years. (iv) Profit tax for the year amounted to $69,500. (v) On 31 March 2011, the board of directors declared a final dividend of $0.1 per ordinary share.

REQUIRED: Prepare an adjusted income statement for the year ended 31 March 2011 in a proper format.

Sea Limited Income statement for the year ended 31 March 2011 $ $ Gross profit 869,000 Less: Expenses Administrative expenses (590,000 – 5,600 ÷ 15 x 12) 585,520 Debenture interest (500,000 x 0.08) 40,000 625,520 Net profit 243,480 Less: Taxation 69,500 Net profit after tax 173,980 Add: Retained profit b/f 150,000 323,980 Less: Appropriations Ordinary share dividend – interim (150,000 x 0.05) 7,500 – final (200,000 x 0.1) 20,000 Preference shares dividend (0.06 x 50,000 x 2) 6,000

p.1 Discount on debentures (500,000 x 0.02 ÷ 5) 2,000 35,500 Retained profits c/f 288,480 HKET Mock (9, 2011) (Issue of shares and debentures) Sun Limited Company plans to have a public offering aims to raise fund of $100 million. The company plans to issue ordinary shares. If the face value for each share is $100, it needs to issue 1 million shares. Sun Limited Company predicts the reactions of three different subscription prices under two scenarios of economic trends. The predicted subscription rates are as follows:

Scenario/Subscription rate Issued at 105 Issued at par Issued at 95 Economy turns good (i) Subscription rate 100% (iii) Subscription rate 105% (v) Subscription rate 120% Economy turns bad (ii) Subscription rate 80% (iv) Subscription rate 90% (vi) Subscription rate 100%

REQUIRED: (a) Based on the subscription situations from (i) to (iv), prepare the necessary journal entries as below for each situation respectively. (1) Received amount on application (2) Share allotment to applicants (3) Return the over subscription amount (if applicable) (Narrations are not required)

Predicting based on the current situation, the probability for the economy to turn good is 60% and that for the economy to turn bad is 40%. REQUIRED: (b) Based on the above prediction, calculate the amount expected to be raised under the three different subscription prices respectively.

An existing shareholder Mr. Chan thinks that issuing debentures is better than issuing ordinary shares. But another shareholder Mr. Lee suggests to issue preference shares, which can relieve what Mr. Chan worried. REQUIRED: (c) Explain in the points of view of shareholder Mr. Chan of what he thinks. (d) Explain how shareholder Mr. Lee’s suggestion can relieve Mr. Chan’s worries.

Sun Limited Company expects all the ordinary shares will be subscribed. And after one year of the issue of shares, the net profit can reach $27,000,000. Assume the profit tax rate is 20%. REQUIRED: (e) Calculate the expected earnings per ordinary shares for the year.

(a) Journal Debit Credit $ $ (i) (1) Bank (1,000,000 x $105 x 100%) 105,000,000 Ordinary share applicants 105,000,000 (2) Ordinary share applicants 105,000,000 Ordinary share capital (1,000,000 x $100) 100,000,000 Share premium (1,000,000 x $5) 5,000,000 (ii) (1) Bank (1,000,000 x $105 x 80%) 84,000,000 Ordinary share applicants 84,000,000 (2) Ordinary share applicants 84,000,000 Ordinary share capital (1,000,000 x $100 x 80%) 80,000,000 Share premium (1,000,000 x $5 x 80%) 4,000,000 (iii) (1) Bank (1,000,000 x $100 x 105%) 105,000,000 Ordinary share applicants 105,000,000

p.2 (2) Ordinary share applicants 100,000,000 Ordinary share capital (1,000,000 x $100) 100,000,000 (3) Ordinary share applicants 5,000,000 Bank (1,000,000 x $100 x 5%) 5,000,000 (iv) (1) Bank (1,000,000 x $100 x 90%) 90,000,000 Ordinary share applicants 90,000,000 (2) Ordinary share applicants 90,000,000 Ordinary share capital (1,000,000 x $100 x 90%) 90,000,000 (v) (1) Bank (1,000,000 x $95 x 120%) 114,000,000 Ordinary share applicants 114,000,000 (2) Ordinary share applicants 95,000,000 Share discount (1,000,000 x $5) 5,000,000 Ordinary share capital (1,000,000 x $100) 100,000,000 (3) Ordinary share applicants 19,000,000 Bank (1,000,000 x $95 x 20%) 19,000,000 (vi) (1) Bank (1,000,000 x $95 x 100%) 95,000,000 Ordinary share applicants 95,000,000 (2) Ordinary share applicants 95,000,000 Share discount (1,000,000 x $5) 5,000,000 Ordinary share capital (1,000,000 x $100) 100,000,000

(b) Issued at 105: Expected amount = $105,000,000 x 60% + $84,000,000 x 40% = $96,600,000 Issued at par: Expected amount = $100,000,000 x 60% + $90,000,000 x 40% = $96,000,000 Issued at 95: Expected amount = $95,000,000 x 60% + $95,000,000 x 40% = $95,000,000

(c) Shareholder Mr. Chan thinks that issuing debentures is better than issuing ordinary shares. This is because ordinary shareholders has voting right. As an existing shareholder, he may worry his existing power to be diluted. On the other hand, issuing debentures can achieve the aim of raising fund and at the same time it can avoid the problem of power being diluted. This is because the debenture holders have no voting right.

(d) Shareholder Mr. Lee suggests to issue preference shares which can solve what shareholder Mr. Chan worried, because preference shareholders have no voting right.

(e) Profit tax = $27,000,000 x 20% = $5,400,000 Profit after tax = $27,000,000  $5,400,000 = $21,600,000 Number of ordinary shares issued = 1,000,000 Expected earnings per ordinary shares = $21,600,000 / 1,000,000 = $21.6

Longman Mock 2011 (Paper 2A, 4) (Issue of shares and debentures)

p.3 4 On 1 April 2012, Everest Ltd announced the issue of $500,000 8% debentures at 105, payable in full on application and repayable on 30 April 2032 at par. Debenture interest is payable on 1 April and 1 October each year.

Applications for $700,000 debentures (par value) were received on 25 April 2012. Allotments were made on 1 May 2012 and the excess application monies were refunded on the same date. Required: (a) Prepare the necessary ledger accounts to record the issuance of debentures. (b) Assuming that the financial year ends on 31 December, calculate the debenture interest for the year ended 31 December 2012. (c) Show the value of debentures appearing in the balance sheet as at 31 December 2012. (Calculations to the nearest dollar)

(a) Bank 2012 $ 2012 $ Apr 25 Debenture applicants May 1 Debenture applicants — Refund ($700,000  105%) 735,000 ($200,000  105%) 210,000

Debenture Applicants 2012 $ 2012 $ May 1 8% debentures 500,000 Apr 25 Bank 735,000 " 1 Debenture premium ($500,000  5%) 25,000 " 1 Bank — Refund 210,000 735,000 735,000

8% Debentures 2012 $ May 1 Debenture applicants 500,000

Debenture Premium 2012 $ May 1 Debenture applicants 25,000

(b) Debenture interest = ($500,000  8%  8/12)  ($25,000  20  8/12) = $25,833

(c)

p.4 Everest Ltd Balance Sheet as at 31 December 2012 (extract) $ Non-current liabilities 8% debentures {$500,000 + [($25,000  ($25,000  20  8/12)]} 524,167

AAT 2011 (Pilot Paper 2, 8) (Issue of shares and debentures) 8. On 1 January 2010, HNH Limited had the following equity and non-current liabilities balances:

10% debentures, repayable in 2017 $140,000 Issued ordinary shares $560,000 Share premium $100,000

The company’s authorized share capital is 1,000,000 ordinary shares of $1.00 each. On 4 April 2010, the company offered for subscription 200,000 ordinary shares of $1.00 each at $1.40 each, payable in full on application.

On 15 June 2010, applications were received for 325,000 shares. As it is an oversubscription, unsuccessful applications were rejected and cash received in respect of these shares was returned on 7 July 2010. Shares were allotted on 8 July 2010.

On 20 October 2010, the company issued 500,000 12% debentures of $1.00 each for cash at par, repayable in 2020. These were secured by the premises of the company. Debentures were fully subscribed.

REQUIRED: (a) Prepare the necessary journal entries to record the above share and debenture issues. (b) Prepare the section of equity and non-current liabilities extracted from statement of financial position as at 31 December 2010. (c) Compute the debt-to-equity ratio before and after the above transactions and briefly comment on it. (d) Identify any THREE pros of each of the above two financing methods used by HNH Limited.

8 (a) Date The Journal Dr Cr 2010 $ $ Jun 15 Bank (325,000 x $1.4) 455,000 Ordinary shares applicants 455,000 Jul 7 Ordinary shares applicants 175,000 Bank (125,000 x $1.4) 175,000 Jul 8 Ordinary shares applicants 280,000 Ordinary shares capital (200,000 x $1.0) 200,000 Share premium (200,000 x $0.4) 80,000 Oct 20 Bank 500,000 12% Debentures, repayable in 2020 500,000

(b) HNH Limited Statement of Financial Position as at 31 December 2010 (extracted) Authorised Capital $ 1,000,000 ordinary shares of $1.00 each 1,000,000

p.5 Equity 760,000 ordinary shares of $1.00 each 760,000 Share premium ($100,000 + $80,000) 180,000 940,000 Non-current liabilities 10% debentures, repayable in 2017 140,000 12% debentures, repayable in 2020 500,000 640,000

(c) Debt-to-equity before financing = Total liabilities / Owners’ equity before financing = $140,000 / ($560,000 + $100,000) = 21.21% Debt-to-equity after financing = Total liabilities / Owners’ equity after financing = $640,000 / ($760,000 + $180,000) = 68.09%

The ratio measures the size of non-current liabilities relative to owners’ equity. Refer to HNH Limited, the ratio is high after financing means that the company relies more on debt financing instead of equity financing.

(d) Pros of issuance of additional share capital — Dividend is not mandatory — More flexibility in its future funding — Funding being permanent — Lower the gearing ratio

Pros of issuance of debentures — Debenture holders do not have voting right granted — Interest paid is tax deductible — Funding being temporary — Able to refinance at lower cost in future

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