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Difficulty: EasyBonus and Rights Issues

When a limited liability company issues bonus shares to its existing ordinary shareholders by capitalizing reserves, what is the effect of this transaction on the company's total cash flow?

  1. Total cash flow remains unchanged because bonus shares are issued free of charge to shareholders using existing capital reserves.Answer
  2. B
    Total cash flow increases because share premium is converted into distributable revenue profit paid in cash.
  3. C
    Total cash flow decreases because owner drawings are debited directly to the capital reserve account.
  4. D
    Total cash flow increases because subscribers must make immediate cash payments for the newly issued shares.

Answer

Total cash flow remains unchanged because bonus shares are issued free of charge to shareholders using existing capital reserves.
The correct answer highlights that a bonus issue is an internal capitalization of reserves. Reserves (like share premium or retained earnings) are transferred to ordinary share capital. No cash is received from shareholders, so cash flow is completely unaffected.

Step-by-Step Solution

1
Identify the nature of a bonus issue
A bonus issue (capitalization issue) represents the issuance of additional shares to existing shareholders without requiring any cash consideration.
It converts undistributed reserves (such as Share Premium or General Reserve) into issued share capital.
2
Analyze the financial impact on cash balances
Because no cash changes hands between the company and its shareholders, the total cash position and total cash flow remain zero/unchanged.
The transaction is purely a bookkeeping entry within the equity section of the balance sheet.

Key Concept

Bonus Issue and Capitalization of Reserves
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Topics

Bonus and Rights Issues

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