Choose company finance for a stated purpose
Compare share issues, rights issues, bonus issues, retained profit and debentures by cash raised, control and repayment risk.
Section 1.5 · Preparation of financial statements
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. These original lessons cover objective 1.5.4: ordinary shares, rights and bonus issues, debentures, dividends, reserves, company statements and finance choices. Preference shares are excluded by the syllabus. The statement formats follow Cambridge Teacher Guidance for 9706 Accounting (examination from 2023). Practice is self-checked, not an official Cambridge grade; full timed-paper practice and human subject-teacher review remain outstanding.
Before you begin
- Use Topics 1.2 and 1.5.1–1.5.3 to interpret double entries, period adjustments and the difference between business profit and an owners’ distribution.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which usually creates a contractual interest obligation: ordinary shares or a debenture?
What you will learn
- Compare share capital and debenture finance
- Evaluate rights issues and bonus issues for company and shareholders
- Recommend a finance source that fits a stated need
Compare the source with the purpose and time horizon
A cash issue of ordinary shares can finance a long-term need without contractual loan interest or repayment, but may dilute existing owners’ voting proportions and shareholders may expect dividends. A rights issue gives existing shareholders an opportunity to maintain their proportional ownership if they take up the offer; not all shareholders may be able or willing to subscribe.
A debenture raises borrowed finance without issuing voting shares, but creates interest and repayment obligations. Retained profit avoids an external finance contract but has an opportunity cost and reduces cash available for other uses. Compare affordability, duration, liquidity, control and the expected benefit of the investment.
Do not confuse a bonus issue with a funding source
A bonus issue does not bring cash into the company. It may alter the number of shares and move amounts between reserves and share capital, but it cannot by itself pay a supplier or buy equipment.
Sources of finance for a specified purpose can include ordinary shares, rights issues, retained profit or debentures. A recommendation should use the specified purpose and evidence. A company with a temporary cash shortage may need a different source from one acquiring a long-lived asset. State a benefit, a cost and one condition that could change the decision rather than naming a universally best source.
Pause and explain
A shareholder does not take up a rights issue. What may happen to that shareholder’s percentage ownership?
Worked example
A company needs $80,000 for a warehouse expected to be used for eight years. It wants to avoid dilution but has limited cash reserves. Compare a debenture with a rights issue and identify the evidence needed before recommending one.
Show the worked solution
- A debenture can raise long-term funds without issuing voting shares, but adds interest and repayment commitments.
- A rights issue avoids mandatory loan repayment and gives existing owners the opportunity to preserve proportions, but may dilute owners who do not subscribe.
- Limited retained cash makes paying the full cost internally risky; compare forecasts, issue terms and the company’s ability to service debt.
- Choose only after comparing expected project cash flows, interest and repayment terms, shareholder take-up and the effect on liquidity.
Answer A debenture may preserve voting control but is suitable only if forecast cash flows can support interest and repayment. A rights issue avoids debt service but depends on shareholder take-up and may dilute non-participants. Review project cash flows, financing terms, take-up and liquidity before choosing.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A company can use $50,000 retained profit or issue a $50,000 debenture to fund a four-year project. Compare one benefit and one cost of each.
Give me a hint
Include an opportunity cost for retained funds and a repayment commitment for borrowing.
Compare my reasoning
- Retained profit avoids new interest and repayment obligations.
- Using retained cash reduces liquidity and prevents other uses of that money.
- A debenture preserves existing share percentages but creates interest and repayment obligations.
Retained profit avoids contractual interest but has an opportunity cost and may weaken liquidity. A debenture preserves voting proportions but adds interest and repayment risk. Compare cash forecasts and other uses of funds.
Look for these in your work
- Both sources evaluated
- Retained-profit opportunity cost stated
- Debenture obligation stated
A company claims a one-for-four bonus issue will raise enough money to pay a $24,000 supplier invoice. Explain the error and suggest two finance sources that could actually bring cash in.
Give me a hint
Distinguish an internal reserve transfer from a transaction paid for by investors or lenders.
Compare my reasoning
- A bonus issue issues shares without receiving cash from shareholders.
- A cash issue of ordinary shares or a rights issue could bring in subscription money if accepted.
- A loan or debenture could bring cash but creates borrowing obligations.
A bonus issue raises no cash, so it cannot pay the invoice. A cash share or rights issue can provide funds if investors subscribe; borrowing can also provide cash but adds interest and repayment obligations.
Look for these in your work
- Bonus issue cash effect corrected
- Equity cash source named
- Borrowing source and cost named
A growing company wants to buy equipment, avoid voting dilution, has enough reserves but expects uneven cash receipts. Recommend a finance direction and explain the key risk to test first.
Give me a hint
Match the desire to avoid dilution with the cash-flow risk of borrowing or using reserves.
Compare my reasoning
- Retained profit avoids new voting shares and contractual interest.
- Using reserves may leave too little working capital when receipts are uneven.
- A debenture preserves voting percentages but creates fixed payments; compare forecast low-cash periods with repayment dates.
Retained profit avoids dilution and interest but may weaken working capital. A debenture preserves voting proportions but requires fixed payments. Compare a monthly cash forecast with the project’s returns and debt terms before recommending either source.
Look for these in your work
- Control preference considered
- Liquidity trade-off considered
- Repayment risk tested against timing
Common mistakes
- Recommending a bonus issue to raise cash
- Calling a rights issue guaranteed finance before considering shareholder take-up
- Choosing a debenture without checking interest and repayment capacity
What can you explain now?
Which finance method changes reserves and share capital without bringing new cash?
Compare with the explanation
A bonus issue
A bonus issue is a reclassification within equity, not a cash issue.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Give one advantage and one disadvantage of a rights issue and a debenture, then state why a bonus issue does not provide finance.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.