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CHAPTER19

ACCOUNTING FOR
LIMITED COMPANIES I
Focal point
 NB: For the purpose of this examination
we are not adopting any one country’s
company legislation considering the
rules set up by International Accounting
Standard.
1 TRADING AS A COMPANY
 Key factors distinguishing companies:
---Separate legal entity concept: the company
is a separate entity in law
---Separation of the ownership (shareholders)
from the management (directors) of the
company
---Limited liability of shareholders for the
debts of a company. Generally speaking, their
liability will be limited to any portion of the
nominal value of shares which is unpaid.
---Formalities required. These vary from
country to country but frequently require public
availability of financial statements an annual
audit by qualified auditors.
Sole traders and companies compared:
 Item Sole trader Company
1 Capital introduced Capital Issued share
by proprietors account capital
2 Loans from Loan Loan notes third
parties account and bonds
3 Profits withdrawn Drawings Dividends
by proprietors
4 Profits retained in Capital Reserves
the business account
Advantages of operating as limited company:
---Liability of the shareholders is limited to
the capital already introduced by them.
--- Formal separation of the business from
owners of the business, which may be helpful to
the running of the business.
--- Ownership can be shared between people
more easily than other forms of business
organization, e.g. a partnership
--- Shares in the business can be transferred
relatively easily.
--- There may be tax advantages.
Disadvantages of operating as limited
company:
--- Costs of formation of the company.
--- Costs of compliance with companies
legislation, including the audit requirement,
if any.
--- Directors’ duties: company directors are
subject to greater legislative duties than
others running an unincorporated business.
--- It is difficult/expensive to return surplus
capital to the shareholders.
--- There may by tax disadvantages
2 COMPANY FINANCE
Principal sources of company finance:
Share
(a) Ordinary shares (equity capital)
Capital (b) Preference shares
(c) Deferred shares
(d) Loan notes and bonds
(e) Bank overdraft
liabilities
(f ) Trade payables
3 SHARE CAPITAL
 Share capital represents part of the capital
invested in the company by its shareholders. It
may also represent past reserves of the
company which have been ‘capitalized’ by a
bonus issue of shares.
 Reserves represent the balance of net assets
accruing to the shareholders. They may include
part of past issues of share capital (known as
share premium ),accumulated profits which
have not been distributed and revaluation gains
on the revaluation of non- current assets.
 The total of share capital and reserves
represents the book value of the net assets
of the company.
 Nominal value of shares :The stated nominal
(or par) value has little practical significance
except as a base line price below which further
shares may not generally be issued. It is also
used as a means of calculating dividends to
shareholders.
 Market value of a share is not fixed at ant
particular date nor is it related to the nominal
value. It is related to the market value of the
business of the company, which may not be the
same value that would apply if the entire
business was sold and thus all the shares were
sold as one transaction.
 Types of share capital
--- Ordinary or equity shares are the
normal shares issued by a company.
--- Rights of ordinary shareholders:
@ to vote at company meetings
@ to receive dividends from profits,
often an interim dividend during an
accounting year and a final dividend
after the balance sheet date when
the company’s profit for the year is
known.
 Ordinary dividends:
---Often expressed in term of cents (or
dollars) per share. Sometimes in
examination questions they are given as
a percentage on the issued share
capital.
---No dividend may be paid on the
ordinary shares until the dividend on the
preference shares has been paid in full.
 Dividends are not expenses of the
company to be deducted in computing
profit, but a share of the final profit paid
to the owners of the company.
 Preference or preferred shares carry a
fixed rate of dividend, the holders of
which have a prior claim to ant company
profits available for distribution.
---Participating preference shares-
where shareholder are entitled to
participate together to a specified extent
in distributable profits and surpluses on
liquidation.
---Redeemable preference shares-the
term of issue specify that they are
repayable by the company.
 Deferred of founders’ shares :their right
to a dividend is deferred until the
preference shareholders have received
their fixed amounts ,and the ordinary
shareholders have received a stated
minimum dividend.
Aspect Ordinary shares Preference shares
Voting power Carry a vote May not carry a
 vote.
Aspect Ordinary shares Preference shares

Distribution A dividend which A fixed dividend 9dix


of profits may vary from one percentage of nominal
( dividends) year to the next after value) in priority to
the preference ordinary dividend.
shareholders have
received their
dividend.
Liquidation Entitled to surplus Priority of repayment
of the assets on liquidation over ordinary shares
company after liabilities and but not usually entitled
preference shares to surplus assets on
have been repaired. liquidation.
4 COMPANY BORROWING
 Notes and bonds
---Notes :debt issued to a single investor
--- Bonds :issue in units to a number of
investors.
--- Holders of notes or bonds are in no way
owners of the business, They receive interest
which is an expense of the company.
--- Notes or bonds may be secured on one or
more assets of the company. If the company
defaults on its payment obligations, those
assets can be sold to raise the required money
for the holders of the notes or bonds.
 Trade payables :unsecured liabilities of
the company for goods and services
supplied to them.
 For the remainder of this chapter we
are concerned with company financial
statements for internal purposes.
5 BALANCE SHEET
 You should be able to produce company
balance sheets in this form when
practicing questions.
XY ltd
Balance sheet as at…
$ $
 Non-current assets (net of
 Accumulated depreciation);
 Land and building X
 Plant and machinery X
 $ $
 Goodwill X
 Investments X
 X
 Current assets:
 Inventory X
 Receivables X
 Cash at bank and in hand X
 X
 X
 Capital and reserves:
 Equity capital X
 Accumulated profits (retain profit) X
 Shareholders’ interest X
 Non-current liabilities:
 Loan notes X
 Current liabilities:
 Trade payables X
 Taxation X
 X
 X
 The shareholders’ interest in the company
consists of the share capital plus reserves an
not merely the equity capital figure.
--- Equity capital is held in the balance sheet
at the same figure year after unless new shares
are issued.
--- Accumulated profit :the company’s profit
for the year minus dividends paid to the
members.
 Accounting for dividends
--- Dividend :a return of part of the profits made
by the company to the shareholders, stated as
percentage based on the nominal value of the
share or as an amount per share.
 Accounting treatment:
Debit Credit With
Accumulated profit Bank Dividend
---Dividends proposed or declared after the
balance sheet date, must not be included as
liabilities in the balance sheet but simply
disclosured in a note (IAS 10 Events after the
Balance Sheet Date)
6 INCOME STATEMENT
XY Ltd
Income statement for the year ended…
 $
 Sales revenue X
 Cost-various analyses can be made (X)
 Net profit before tax X
 Income tax (X)
 Net profit after tax X
The income statement is followed by a
statement of changes in equity for the year,
including dividends and reserve movements.
 Statement of changes in equity

Ordinary Share Revaluation Accumulated total


share premium reserve profit
capital
$’000 $’000 $’000 $’000 $’000
Opening X X X X X
balance
Surplus on X X
revaluation
Net profit for X X
period
Dividends (X)
Ordinary (X)
Preference (X)
Issue of X X
share
capital
Closing X X X X X
balance
 Company tax is normally payable after
the end of the accounting period. The
entry to record the liability in the financial
statements is:
Debit Credit With
Income The payable (shown estimate
statement as current liability on of tax
balance sheet) charge
7 ISSUE OF SHARES
 Authorized share capital :the maximum
number of shares a company may issue.
 Issued share capital :the actual number of
shares in issue at ant point in time. This
appears on a company’s balance sheet.
 Accounting treatment:
Issue of $100000 shares at nominal value:
Debit Credit With
Cash book Ordinary share capital Nominal

account value
Issue of $100000 nominal value for
$300000:
Debit Credit With
 Cash book $300000
 Ordinary share capital $100000
 account
 Share premium account $200000
Balance sheet extract
 $
 Capital and reserves;
 Share capital-$ 1 ordinary shares 100000
 Share premium account 200000
 Accumulated profit X
 Bonus issue (a bonus, script or capitalization
issue): the issue of shares to existing
shareholders in proportion to their existing
holdings, using the reserves of the company. It
is effectively the conversion of part of the
reserves of the company into share capital.
---No cash or other consideration is passed
from shareholders to the company
--- Accounting treatment:
Debit Credit With
Reserves Share capital Amount
of bonus issue
--- Any reserve may be used to finance
the bonus issue. A reserve which cannot
be distributed ,liked share premium,
would be used in preference to reserves
which can be distributed.
--- With a bonus issue:
# Issue share capital is brought more
into line with the assets employed in the
company
# Issued share capital is divided into a
large number of shares.
# Market price per share falls, roughly
pro rata to the bonus issue.
--- Rights issue :the offer of shares to
existing shareholders in proportion to
their existing holding at a stated price.
--- Unlike the bonus the shareholders do
not have to take up their offer and have
the alternative of selling their rights on
the stock market.
--- Accounting treatment:
Debit Credit With
 Cash book Proceeds
 Share capital Nominal value
 Share premium Premium (if
any)
--- A right issue is the cheapest way a company
can raise further finance by the issue of shares.
--- A right issue to existing shareholders has a
greater chance of success, i.e. actually finding
buyers compared to a share issue to the public.
--- It may be more appropriate compared to
issuing loan notes or bonds if further profits will
take a long time to arise from additional
investments (i.e. interest does not have to be
paid)
But:
--- A rights issue is more expensive than issuing
debt (loan notes or bonds)
--- It may not be successful in raising the
finance required.
8 RESERVES
 All reserves are added to the share capital to
build up the total shareholders’ interest in the
company.
 Capital reserves
--- Share premium reserve :the excess of the
issue price if a share over its nominal value. It is
normally against the law to distribute the share
premium as dividend.
--- Revaluation reserve :the excess of the new
value over the previous book value (carrying
value) .It arise when an increase in the value of
a non-current asset is recognized.
 Revenue reserves
--- The profit for the year9after allowing for
expenses and taxation) may be dealt with as
follows:
Profit after tax

1 2 3

Transfers to Balance of
Dividends paid specific named accumulated
reserves profit
 Accumulated profit :total profit made by the
company since it was formed, minus dividends
paid or payable. In most countries, only this is
distributable as dividend, though all reserves
may be converted into share capital by means
of a bonus issue.
 Named reserves: the directors are indicating
that these amounts are not available to support
a dividend payment.
--- Plant replacement reserve: In a time of plant
price inflation each year profit is reduce by a
further amount (over an above historical cost
depreciation) which is transferred to this
reserve so that assets van be replaced when
necessary.
* Inventory replacement reserve: same principle.
* General reserve: no specific purpose for the
reserve. Although legally the reserve can be
distributed as a dividend, the directors are
indicating that it is not available for distribution.
 Accounting treatment:
 Debit Credit With
 Accumulated profit Plant replacement Additional
 reserve depreciation
 Accumulated profit Inventory Additional
 replacement deduction
relating
 reserve to cost of sales
 Accumulated profit General transfer to
 reserve general reserve
9 DRAFTING COMPANY
FINANCIAL STATEMENT FOR
INTERNAL USE
 Typically, an exam question will ask you
to draft an income statement and balance
sheet from a trial balance plus some
additional information
 Step1 Performa income statement and
balance sheet layouts, and a statement of
changes in equity if required. Have a
separate page to hand headed' Workings’
 Step 2 Slot in any figures straight from
the trial balance if you can.
 Step 3 Where items require workings,
sketch T accounts and label them. This
should help you to be clear in your mind
that you are getting the double entry
right. Some workings can be done on
the face of the income statement or
balance sheet.

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