An introduction to the accounts of limited companies (AS Level) Financial accounting

 

Defining a Limited Company

A limited company is a unique type of organisation because it is a separate legal entity. Its existence is legally separate from that of its owners, who are known as shareholders.

This structure is the basis for the term "limited liability companies," where the liability of shareholders is limited to the amounts they have paid, or agreed to pay, for their shares. This contrasts sharply with a partnership or sole trader, where the owners' liability is usually unlimited, meaning their private assets could be seized to satisfy the firm's creditors.

Limited Companies vs. Partnerships

Limited companies differ from partnerships in several key ways:

Feature

Partnerships

Limited Companies

Legal Status

Unlimited liability (private assets seized).

Liability limited to amounts paid/agreed on shares.

Owners

Partners.

Shareholders (members).

Maximum Owners

Usually not more than 20 partners (with exceptions).

Public limited companies have no maximum; private companies usually have a restriction set by the Articles of Association.

 

Types of Limited Companies

Companies register as either public or private:

  • Public Limited Company (plc): May offer shares to the public and arrange for those shares to be traded on the stock exchange.
  • Private Limited Company (Ltd): Cannot offer shares to the public and shares cannot be bought and sold on the stock exchange.

 Legal and Governance Framework

The accounting and operation of limited companies in the UK are governed primarily by the UK Companies Act 2006, designed to protect creditors and shareholders.

Key Formation Documents

When a company is formed, founders register specific documents with the Registrar of Companies:

  • Articles of Association: This is the main constitutional document defining the company's existence. It regulates its structure, internal control, directors’ powers, appointment/removal of directors, and the issue and transfer of shares.
  • Memorandum of Association: Defines the company’s relationship to the outside world, including stating the company name (ending in 'plc' or 'Limited/Ltd') and declaring that the liability of the company is limited.

 Capital Structure and Financing

Share Capital and Debentures

A company raises funds primarily through the issue of shares and loans:

  • Share Capital: The capital raised by the issue of shares. Shares represent equity ownership (Ordinary Shares) or preference rights (Preference Shares). The minimum value of a share is its nominal (or par) value.
    • If shares are issued at a price exceeding the nominal value, the excess amount is credited to the Share Premium account.
  • Debentures: A debenture is a document given for a loan to the company, making debenture holders creditors, not members. They are entitled to fixed interest, which must be paid even if the company does not make a profit, and this interest is treated as an expense (Finance cost) in the income statement.

Reserves

There are two classes of reserves:

  1. Revenue Reserves: These arise from accumulated profits that have not been distributed to shareholders. Examples include Retained Earnings and General Reserves.
  2. Capital Reserves: These usually represent unrealised gains from non-trading activities, such as the revaluation of non-current assets (Revaluation Reserve). Capital Reserves cannot be used to pay cash dividends.

 Financial Statements and Reporting

Limited companies must follow accounting principles set out in the International Accounting Standard 1 (IAS 1) when preparing their financial statements.

The core annual financial statements and reports that must be prepared and published are:

  • Income Statement: Prepared periodically to determine the profit or loss made by the business. It lists revenue, subtracts cost of sales to find Gross Profit, and then deducts operating expenses (like Distribution Costs and Administrative Expenses), and Finance Costs (such as debenture interest) to arrive at the Profit Before Tax.
  • Statement of Financial Position (SFP): A list of assets, liabilities, capital, and reserves at a specific point in time. It includes non-current assets and liabilities, current assets and liabilities, and the total equity (share capital and reserves/retained earnings).
  • Statement of Changes in Equity: Shows the movement in the company's share capital, reserves, and retained earnings over the reporting period. It explicitly tracks the impact of profits for the year, transfers to reserves, and dividends paid.
  • Statement of Cash Flows (IAS 7).
  • Directors’ Report.
  • Auditor’s Report: Provides a statement to shareholders confirming whether the financial statements present a true and fair view of the company's affairs.

Distributing Profit

After tax is paid on the profit for the year, the profit remaining must be divided. This is done by paying dividends to shareholders and retaining the balance as retained earnings. Distributable profits consist of the company's accumulated realised profits which have not been distributed, minus any accumulated realised losses.

The payment of dividends to shareholders is considered an appropriation of profit, distinguishing it from debenture interest, which is an expense.

 

 

Download PDF 

 

 

0 Reviews