ACCA Financial Accounting (FA/F3)

Financial management is a fundamental factor of every business operation. Understanding how a business is financed is important for all aspiring accountants. Within the ACCA Financial Accounting (FA/F3) syllabus, two important topics stand out, i.e., Capital Structure and Finance Costs. These topics help students learn the key financial strategies that businesses use and how these decisions affect financial statements and overall performance. The section below provides a detailed overview of capital structure and finance costs following the FA/F3 syllabus.

What is Capital Structure?

Capital structure refers to how a company finances its operations and growth through different sources of funds. It mainly consists of equity and debt capital. A perfect capital structure hits a balance between cost, control, and risk to maximize shareholder value.

Formula: Capital Structure = Equity Capital + Debt Capital + Retained Earnings

Components of Capital Structure

Capital structure consists of various funding sources, each playing a unique role in financing a company's operations and growth. Understanding the components of capital structure is important for estimating financial stability, the cost of capital, and the importance of control. Below are the essential elements of capital structure, along with their specific facts and importance.

1. Equity Capital

• Raised from shareholders.

• Includes common shares and preferred shares.

• Carries ownership rights and voting power.

• Dividends are not obligatory.

2. Debt Capital

• Borrowed funds from banks, institutions, or public (debentures).

• Involves repayment with interest.

• Interest is a finance cost and tax-deductible.

3. Preference Share

• Fixed Dividend payments

• Non-voting rights in most cases.

• Types: Cumulative, Non-Cumulative, Redeemable, Convertible.

Types of Capital

The types of capital are important for assessing how a business secures funding. Each type i.e. equity, debt, and hybrid has different costs, risks, and implications for ownership. The table below outlines the main capital categories with examples and key characteristics.

Importance of Capital Structure in ACCA FA/F3

ACCA FA/F3 exam, capital structure is an important topic. It helps students understand how businesses use debt and equity to raise money. Knowing this helps when preparing financial statements and making decisions about business financing. Below are the importance of capital structure in ACCA FA/F3:

• Drafting balance sheets and income statements

• Analysing financial risk and leverage

• Assessing profitability and long-term solvency

• Answering exam questions on journal entries, ratios, and financing

What is Finance Cost?

Finance costs refer to the expenses incurred when borrowing funds. According to IAS 23 - Borrowing Costs, finance costs include interest and other related expenses associated with borrowing funds. Example of Finance costs includes Interest on bank loans, Lease interest (IFRS 16), Overdraft interest, and Loan processing fees.

Types of Finance Cost

Finance costs refer to various expenses that a company incurs when borrowing money. These costs vary based on the method of borrowing and the terms involved. The table below lists some common types of finance costs along with examples.

Difference Between Capital Structure and Finance Cost

Capital structure refers to the methods a company uses to finance its operations, such as through loans or by issuing shares. On the other hand, finance costs are paid to cover the expenses a company incurs when it borrows money, such as interest payments on loans. The table below outlines the differences between capital structure and finance cost:

Accounting Treatment of Capital Structure and Finance Cost

In accounting, both capital structure and finance cost are treated differently in the financial statements. Capital structure affects how funds are presented in the balance sheet, while finance cost deals with the expenses of borrowing and is recorded in the income statement. Check below for the accounting treatment of capital structure and finance cost:

Capital Structure Treatment

• Equity instruments are listed under equity and debt instruments under liabilities on the balance sheet.

• Share capital, share premium, and retained earnings appear under equity.

• Borrowings such as loans and debentures appear under liabilities.

• No direct expense was recorded in the income statement from capital raised.

Finance Cost Treatment

• Finance costs are treated as expenses in the income statement.

• The finance costs are reported separately from the operating profit.

• Revenue should be recognized on an accrual basis.

• According to IAS 23, borrowing costs that are directly linked to obtaining or creating a qualifying asset must be capitalized.