Page 25 - CIMA MCS Workbook May 2019 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

Exercise 2

Jord is a privately owned business, which paid a dividend to its shareholders in respect of the
financial results for 2017 and 2018. The size of the dividend paid may be a reflection of meeting
the expectations of the institutional shareholders. It would be useful to obtain information
regarding directors’ remuneration to gain a clearer picture.

Jord currently has no loan finance and is therefore an ungeared entity financed solely by equity
finance.

If Jord needed to raise finance (perhaps to acquire an interest in another entity or to support
capital expenditure plans in PPE), it could access the following sources of finance:

 Current resources. Jord has a cash and equivalents balance of over C$26m at 31 December
1018, an increase of almost C$10m on the previous year.

 A rights issue to current shareholders on a pro‐rata basis. This would have the advantage of
current shareholders maintaining their current proportionate interest in the entity. There
would be no dilution of shareholder interest and control would not be affected. This would
have the advantage of Jord remaining as an ungeared entity which may appeal to the
current owners/managers. However, it would be subject to the financial constraints of the
current shareholders.

 An issue of a different class of shares to current or new shareholders. This separate class of
shares may have restricted rights to vote/dividend entitlement and/or capital redemption
at a later date. The specific characteristics of the share issue would need to be considered
carefully to ensure that it is correctly classified as either equity or liability in the SOFP. If
classified as a liability, it would introduce an element of gearing into the capital structure of
Jord.

 The issue of a compound instrument (e.g. convertible loan stock) could also be used to raise
finance. As with the issue of a separate class of shares, the classification of the compound
instrument would need to be properly reflected in the SOFP. Normally, this consists of
recognition of the present value of the obligation (including the obligation to convert the
liability into shares or pay cash), with a residual equity element.

 A bank loan. This would introduce an element of gearing into the capital structure of Jord.

Based upon information available, Jord owns the premises and they could be used as
security for any loan finance agreed. If the loan was secured against the premises, Jord
would need to ensure that it complied with the terms and conditions of the loan
agreement, or be at risk of losing possession of the premises. A loan agreement may also
impose restrictions upon the level of directors’ remuneration and/or dividends paid to
shareholders.

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