CAF-1 · Chapter 8
Statement of Changes in Equity MCQs with Answers
15 multiple-choice questions on Statement of Changes in Equity for CAF-1 Financial Accounting and Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following is considered a 'revenue reserve' (distributable reserve) in the statement of changes in equity?
- A) Share premium.
- B) Retained earnings.
- C) Revaluation surplus.
- D) Issued share capital.
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Answer: B) Retained earnings.
Retained earnings and general reserves are classified as revenue (distributable) reserves, whereas share premium and revaluation surplus are capital (non-distributable) reserves.
Question 2
How should a final dividend declared just after the year-end be presented in the financial statements for that year?
- A) Deducted from retained earnings in the statement of changes in equity.
- B) Recognized as a liability in the statement of financial position.
- C) Disclosed only in the notes to the financial statements.
- D) Deducted from profit or loss as a finance cost.
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Answer: C) Disclosed only in the notes to the financial statements.
A dividend declared after the reporting period is a non-adjusting event and is only disclosed in the notes; it is not recognized as a liability or deducted from equity at year-end.
Question 3
Where must an entity present the amount of dividends recognized as distributions to owners during the period?
- A) Only in the statement of profit or loss.
- B) Either in the statement of changes in equity or in the notes.
- C) Exclusively in the statement of cash flows.
- D) In the statement of financial position as a deduction from total assets.
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Answer: B) Either in the statement of changes in equity or in the notes.
An entity shall present, either in the statement of changes in equity or in the notes, the amount of dividends recognized as distributions to owners during the period.
Question 4
Which of the following causes an overall change in equity during a period?
- A) Total comprehensive income for the period.
- B) A transfer from retained earnings to a general reserve.
- C) A bonus issue of shares out of retained earnings.
- D) A share split.
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Answer: A) Total comprehensive income for the period.
Total comprehensive income represents income and expenses that increase or decrease equity. Transfers between reserves or bonus issues merely reclassify amounts within equity without changing the overall total.
Question 5
An interim dividend of Rs. 15 million is paid during the financial year. How is this recorded in the financial statements?
- A) As an administrative expense in profit or loss.
- B) As a deduction from retained earnings in the statement of changes in equity.
- C) As a deduction from share premium.
- D) As an operating cash inflow.
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Answer: B) As a deduction from retained earnings in the statement of changes in equity.
Dividends paid during the year represent distributions to owners and are deducted directly from retained earnings in the statement of changes in equity.
Question 6
What is the primary purpose of a 'Dividend Equalization Reserve'?
- A) To write off preliminary formation expenses.
- B) To ensure that dividends remain stable irrespective of fluctuations in annual earnings.
- C) To legally restrict the entity from paying any dividends.
- D) To hold funds specifically for the redemption of preference shares.
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Answer: B) To ensure that dividends remain stable irrespective of fluctuations in annual earnings.
A dividend equalization reserve is a specific reserve created out of retained earnings to ensure that dividends remain stable irrespective of changes in earnings.
Question 7
Which of the following is NOT permitted to be charged or credited to the Share Premium account?
- A) Premium payable on the redemption of redeemable preference shares.
- B) Issuance of bonus shares.
- C) Routine annual cash dividends paid to ordinary shareholders.
- D) Transaction costs relating to the issue of new shares.
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Answer: C) Routine annual cash dividends paid to ordinary shareholders.
Share premium is a capital reserve and cannot be used to pay routine cash dividends. It can be used for bonus shares, writing off issue costs, or premiums on redemption.
Question 8
A company issues a 10% bonus share to its existing shareholders out of retained earnings. What is the net effect on total equity?
- A) Total equity increases by 10%.
- B) Total equity decreases by 10%.
- C) Total equity remains unchanged.
- D) Total equity increases by the nominal value of the shares issued.
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Answer: C) Total equity remains unchanged.
A bonus issue capitalizes reserves (e.g., retained earnings decrease while share capital increases), resulting in zero net change to total equity.
Question 9
When an entity discovers a material error from a prior period, how is the correction presented in the statement of changes in equity?
- A) As a separate line item adjusting the closing balance of the current period.
- B) As an adjustment to the opening balance of retained earnings for the earliest period presented.
- C) It is ignored in equity and charged directly to current year profit or loss.
- D) As an item of other comprehensive income.
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Answer: B) As an adjustment to the opening balance of retained earnings for the earliest period presented.
The effects of retrospective restatement for prior period errors must be shown as an adjustment to the opening balance of retained earnings (or other relevant equity component) for the earliest period presented.
Question 10
Which document explicitly presents the reconciliation between the carrying amount of each component of equity at the beginning and end of the period?
- A) Statement of financial position.
- B) Statement of profit or loss.
- C) Statement of changes in equity.
- D) Statement of cash flows.
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Answer: C) Statement of changes in equity.
The statement of changes in equity provides a reconciliation between the carrying amount at the beginning and the end of the period for each component of equity.
Question 11
In the statement of changes in equity, what is the effect of transferring Rs. 20 million from retained earnings to a general reserve?
- A) Total equity increases by Rs. 20 million.
- B) Total equity decreases by Rs. 20 million.
- C) Retained earnings decrease and general reserves increase, with no change to total equity.
- D) The transfer is recognized as an expense in profit or loss.
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Answer: C) Retained earnings decrease and general reserves increase, with no change to total equity.
Transfers between reserves (such as from retained earnings to general reserves) are internal reclassifications within equity and do not change the total equity balance.
Question 12
A company issues 1 million ordinary shares of Rs. 10 each at a price of Rs. 15 per share. How is the Rs. 5 per share excess recorded?
- A) Credited to the statement of profit or loss as revenue.
- B) Credited to the share premium account.
- C) Credited to retained earnings.
- D) Credited to the revaluation surplus.
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Answer: B) Credited to the share premium account.
When a company issues shares at a price higher than their nominal (par) value, the excess amount is credited to a capital reserve known as the share premium account.
Question 13
Which of the following is an example of an item that is recognized in 'Other Comprehensive Income' and subsequently appears in the statement of changes in equity?
- A) Routine administrative salaries.
- B) Gain on revaluation of property, plant and equipment.
- C) Interest expense on a bank loan.
- D) Cash received from customers.
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Answer: B) Gain on revaluation of property, plant and equipment.
Revaluation surplus arising from the revaluation of PPE is recognized in Other Comprehensive Income and accumulates in equity as a capital reserve.
Question 14
Which of the following statements about irredeemable preference shares is true in the context of equity?
- A) They are always classified as a non-current liability.
- B) They form part of the entity's share capital within equity.
- C) Dividends paid on them are treated as a finance cost.
- D) They must be redeemed within 12 months.
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Answer: B) They form part of the entity's share capital within equity.
Irredeemable preference shares do not have a mandatory repayment obligation, so they are classified as part of share capital within equity.
Question 15
Transaction costs directly related to the issuance of new shares should be:
- A) Expensed immediately in the statement of profit or loss.
- B) Capitalized as an intangible asset.
- C) Deducted from equity (typically from share premium if available).
- D) Added to the nominal value of share capital.
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Answer: C) Deducted from equity (typically from share premium if available).
Transaction costs directly related to the issue of shares are accounted for as a deduction from equity, typically debited against the share premium account if one exists, or retained earnings.