Share Capital and Reserve for Limited Companies

(a) Share premium → capital reserve → cannot pay a cash dividend. (b) General reserve → revenue reserve → can pay a cash dividend. (c) Revaluation reserve → capital reserve → cannot pay a cash dividend. (d) Retained earnings → revenue reserve → can pay a cash dividend.

Share capital = 250,000 × 1.00 = $250,000. Share premium = 250,000 × (1.40 − 1.00) = $100,000.

(a) Distributable (revenue) reserves = general reserve 40,000 + retained earnings 160,000 = $200,000.

(b) The share premium and revaluation reserve are capital reserves. They arise from non-trading events (issuing shares above par; revaluing an asset) and represent capital, not realised trading profit, so paying them as a cash dividend would return capital to shareholders — they are therefore not distributable as cash dividends.

Closing retained earnings = 110,000 + 54,000 (profit) − 25,000 (dividends) − 18,000 (transfer to general reserve) = $121,000.

(a) Increase = 640,000 − 500,000 = $140,000. Dr Land and buildings $140,000; Cr Revaluation reserve $140,000.

(b) The gain on revaluation is unrealised — the asset has not been sold, so no cash or realised profit has arisen. The prudence concept prevents recognising an unrealised gain as profit, because it could lead to overstating profit and paying it out as a dividend. Instead it is held in the revaluation reserve, a capital reserve that is not distributable as a cash dividend until (and unless) the asset is sold and the gain realised.

Equity

Total equity = $520,000, which equals the company's net assets.

A capital reserve arises from non-trading transactions — for example the share premium (issuing shares above their nominal value) or the revaluation reserve (revaluing a non-current asset upwards). It represents capital, not realised profit, and is not available to pay cash dividends.

A revenue reserve arises from trading profits retained in the business — for example retained earnings or a general reserve. It represents realised, undistributed profit and is available to pay cash dividends.

So the two differ in origin (non-trading vs trading) and in whether they are distributable as cash dividends.

Legally distributable. Retained earnings of $300,000 are a revenue reserve, so a dividend of $250,000 is within the distributable reserves and is legally possible.

But cash is the constraint. Paying a $250,000 cash dividend requires $250,000 of cash, whereas the company has only $45,000. The retained earnings represent profits that may be tied up in non-current assets, inventory or receivables, not held as cash. A large retained earnings balance does not guarantee the cash to pay it.

Consequences of overpaying. Paying more than the company can afford would leave it unable to meet its other obligations (suppliers, wages, loan repayments), risking liquidity problems or insolvency, and possibly forcing it to borrow.

Conclusion. The company should not pay $250,000. It should pay a smaller dividend that its cash position can support (closer to its available cash, leaving a buffer), or raise additional finance first. The decision must be based on both distributable reserves and available cash, not reserves alone.

The transfer reduces retained earnings by $30,000 and increases the general reserve by $30,000. Both are revenue reserves within equity, so total equity is unchanged and no cash moves — it is purely a bookkeeping transfer (Dr Retained earnings, Cr General reserve).

Its purpose is to earmark part of the retained profit for general future needs, signalling that the directors do not intend to distribute it routinely. Because the general reserve is still a revenue reserve, the amount remains distributable as a cash dividend in the future if the directors choose.

Authorised share capital is the maximum amount of share capital a company is permitted to issue. Issued share capital is the amount it has actually issued to shareholders. Only the issued capital appears in the statement of financial position.