COMPANY ACCOUNTS

Limited liability companies, more commonly referred to as limited companies, came into
existence originally because of the growth in the size of businesses, and the need to have a lot of
people investing in the business who would not be able to take part in its management.

Limited liability

The capital of a limited company is divided into shares. Shares can be of any nominal value –10
butut, 25butut, D1, D5, D10, or any other amount per share. To become a member of a limited
company, or a shareholder, a person must buy one or more of the shares. If shareholders have
paid in full for their shares, their liability is limited to what they have already paid for those shares.
If a company loses all its assets, all those shareholders can lose is their share. They cannot be
forced to pay anything more in respect of the company’s losses. Shareholders who have only partly
paid for their shares can be forced to pay the balance owing on the shares, but nothing else.
Shareholders are therefore said to have ‘limited liability’ and this is why companies are known as
‘limited liability’ or, more usually, simply ‘limited’ companies. By addressing the need for
investors to have limited risk of financial loss, the existence of limited liability encourages
individuals to invest in these companies and makes it possible to have both a large number of
owners and a large amount of capital invested in the company.

Public and Private Companies

There are two classes of company, the public company and the private company. In the
Companies Acts, a public company is defined as one which fulfils the following conditions:

o Its memorandum (a document that describes the company) states that it is a public
company, and that it has registered as such.
o It has an authorised share capital of at least £50,000.
o Minimum membership is two. There is no maximum.
o Its name must end with the words ‘public limited company’ or the abbreviation
‘PLC’.

A private company is usually, but not always, a smaller business, and may be formed by one or
more persons. It is defined by the Act as a company which is not a public company. The main
differences between a private company and a public company are that a private company

• can have an authorised capital of less than £50,000,

• and cannot offer its shares for subscription to the public at large, whereas public companies
can.

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This means that if you were to walk into a bank, or similar public place, and see a prospectus
offering anyone the chance to take up shares in a company, then that company would be a public
company, i.e. a PLC. The shares that are dealt in on the Stock Exchange are all of public limited
companies. This does not mean that all public companies’ shares are traded on the Stock Exchange,
as, for various reasons, some public companies have either chosen not to, or not been allowed to
have their shares traded there. The ones whose shares are traded are known as ‘quoted companies’
meaning that their shares have prices quoted on the Stock Exchange. They have to comply with
Stock Exchange requirements in addition to those laid down by the Companies Acts and
accounting standards.

Directors of the company

The day-to-day business of a company is not carried out by the shareholders. The possession of a
share normally confers voting rights on the holder, who is then able to attend general meetings of
the company. At one of these general meetings, normally the Annual General Meeting or AGM,
the shareholders vote for directors, these being the people who will be entrusted with the running
of the business. At each AGM, the directors report on their stewardship, and this report is
accompanied by a set of financial statements for the year – the ‘annual report’.

Legal status of a limited company

A limited company is said to possess a ‘separate legal identity’ from that of its shareholders. Put
simply, this means that a company is not seen as being exactly the same as its shareholders. For
instance, a company can sue one or more of its shareholders, and similarly, a shareholder can sue
the company. This would not be the case if the company and its shareholders were exactly the
same thing, as one cannot sue oneself.

Share capital

Shareholders of a limited company obtain their reward in the form of a share of the profits, known
as a dividend. The directors consider the amount of profits and decide on the amount of profits
which are placed to reserves. Out of the profits remaining the directors then propose the payment
of a certain amount of dividend. It is important to note that the shareholders cannot propose a
higher dividend for themselves than that already proposed by the directors. They can, however,
propose that a lesser dividend should be paid, although this action is very rare indeed. If the
directors propose that no dividend be paid, then the shareholders are powerless to alter the decision.
The decision by the directors as to the amount proposed as dividends is a very complex one and
cannot be fully discussed here. Such points as government directives to reduce dividends, the effect
of taxation, the availability of bank balances to pay the dividends, the possibility of takeover bids
and so on will all be taken into account.

The dividend is usually expressed as a percentage. A dividend of 10 per cent in Business A on

500,000 ordinary shares of £1 each will amount to £50,000, while a dividend of 6 per cent in

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Business B on 200,000 ordinary shares of £2 each will amount to £24,000. A shareholder having

100 shares in each business would receive £10 from Business A and £12 from Business B.

There are two main types of shares:

1. Preference shares. Holders of these shares get an agreed percentage rate of dividend before
the ordinary shareholders receive anything. There are two main types of preference shares.

a. Non-cumulative preference shares. These can receive a dividend up to an agreed

percentage each year. If the amount paid is less than the maximum agreed amount, the
shortfall is lost by the shareholder. The shortfall cannot be carried forward and paid in a
future year.
b. Cumulative preference shares. These also have an agreed maximum percentage
dividend.
However, any shortfall of dividend paid in a year can be carried forward. These arrears of
preference dividends will have to be paid before the ordinary shareholders receive
anything.

2. Ordinary shares. Holders of these shares receive the remainder of the total profits
available for dividends. There is no upper limit to the amounts of dividends they can
receive.

Share capital: different meanings

The term ‘share capital’ can have any of the following meanings:

1. Authorised share capital. Sometimes known as registered capital or nominal capital. This
is the total of the share capital which the company is allowed to issue to shareholders.
2. Issued share capital. This is the total of the share capital actually issued to shareholders.

NB: If all of the authorised share capital has been issued, then 1 and 2 above would be the same
amount.

3. Called-up capital. Where only part of the amount payable on each issued share has been
asked for, the total amount asked for on all the issued shares is known as the called-up
capital.
4. Uncalled capital. This is the total amount which is to be received in future relating to
issued share capital, but which has not yet been asked for.
5. Calls in arrears. The total amount for which payment has been asked for (i.e. ‘called
for’), but has not yet been paid by shareholders.
6. Paid-up capital. This is the total of the amount of share capital which has been paid for
by shareholders.

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Example: Use the following information to answer the questions below:

1 Better Enterprises Ltd was formed with the legal right to issue 1 million shares of £1 each.
2 The company has actually issued 750,000 shares.
3 None of the shares has yet been fully paid up. So far, the company has made calls of 80p (£0.80)
per share.
4 All the calls have been paid by shareholders except for £200 owing from one shareholder.

Required:

a. How much is :
i. Authorized share capital
ii. Issued share capital
iii. Called-up capital
iv. Uncalled capital
v. Call in arrears
vi. Paid-up capital
Debentures

The term debenture is used when a limited company receives money on loan, and certificates
called debenture certificates are issued to the lender. Interest will be paid to the holder, the rate of
interest being shown on the certificate. They are not always called debentures; they are often
known as loan stock or as loan capital. Debenture interest has to be paid whether profits are made
or not. They are, therefore, different from shares, where dividends depend on profits being made.
A debenture may be either:

• Redeemable, i.e. repayable at or by a particular date, or

• Irredeemable, normally repayable only when the company is officially terminated by its
going into liquidation. (Also sometimes referred to as ‘perpetual’ debentures.)

If a date is shown behind a debenture, e.g. 2005/2012, it means that the company can redeem it in
any of the years 2005 to 2012 inclusive. People lending money to companies in the form of
debentures will be interested in how safe their investment will be. Some debentures are given the
legal right that on certain happenings the debenture holders will be able to take control of specific
assets, or of the whole of the assets. They can then sell the assets and recoup the amount due under
their debentures, or deal with the assets in ways specified in the deed under which the debentures
were issued. Such debentures are known as being ‘secured’ against the assets – this was the case
in the veil of incorporation note. (The term ‘mortgage’ debenture is sometimes used instead of
‘secured’.) Other debentures have no prior right to control the assets under any circumstances.
These are known as ‘simple’ or ‘naked’ debentures.

Trading and profit and loss accounts of companies

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The trading and profit and loss accounts for both private and public companies are drawn up in
exactly the same way. The trading account of a limited company is no different from that of a sole
trader or a partnership. However, some differences may be found in the profit and loss account.
The two main expenses that would be found only in company accounts are directors’ remuneration
and debenture interest.

Directors’ remuneration: As directors exist only in companies, this type of expense is found only
in company accounts. Directors are legally employees of the company, appointed by the
shareholders. Their remuneration is charged to the profit and loss account.

Debenture interest: The interest payable for the use of the money is an expense of the company,
and is payable whether profits are made or not. This means that debenture interest is charged as an
expense in the profit and loss account itself. Contrast this with dividends which are dependent on
profits having been made.

The appropriation account

Next under the profit and loss account is a section called the ‘profit and loss appropriation account’.
The appropriation account shows how the net profits are to be appropriated, i.e. how the profits
are to be used. This is similar in nature to the appropriation account you learnt about when you
looked at partnership accounts, in that it involves distributing the profit. However, that is as far as
the similarity goes.

We may find any of the following in the appropriation account:

Credit side

1 Net profit for the year. This is the net profit brought down from the main profit and loss account.

2 Balance brought forward from last year. As you will see, all the profits may not be
appropriated during a period. This then will be the balance on the appropriation account, as brought
forward from the previous year. It is usually called retained profits.

Debit side

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3 Transfers to reserves. The directors may decide that some of the profits should not be included
in the calculation of how much should be paid out as dividends. These profits are transferred to
reserve accounts. There may be a specific reason for the transfer such as a need to replace fixed
assets. In this case an amount would be transferred to a fixed assets replacement reserve. Or the
reason may not be specific. In this case an amount would be transferred to a general reserve
account.

4 Amounts written off as goodwill. Goodwill, in a company, may have amounts written off it
from time to time. When this is done the amount written off should be shown in the appropriation
account and not in the main profit and loss account.

5 Preliminary expenses. When a company is formed, there are many kinds of expenses concerned
with its formation. These include, for example, legal expenses and various government taxes.

6 Taxation payable on profits. In the case of companies, the taxation levied upon them is called
corporation tax. It is also based on the amount of profits made. In the later stages of your
examinations you will learn how to calculate it. At this point you will be told how much it is, or
be given a simple arithmetical way of ascertaining the amount. Corporation tax is not an expense,
it is an appropriation of profits. Instead, it is shown as a deduction from profit for the year before
taxation (i.e. this is the net profit figure) to show the net result, i.e. profit for the year after taxation.

7 Dividends. Out of the remainder of the profits the directors propose what dividends should be
paid.

8 Balance carried forward to next year. After the dividends have been proposed there will
probably be some profits that have not been appropriated. These retained profits will be carried
forward to the following year

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Example:

The following trial balance is extracted from the books of F W Ltd as on 31 December 20X5:

Trial balance as on 31 December 20X5

Dr Cr

£ £

10% preference share capital 200,000

Ordinary share capital 700,000

10% debentures (repayable 20X9) 300,000

Goodwill at cost 255,000

Buildings at cost 1,050,000

Equipment at cost 120,000

Motor vehicles at cost 172,000

Provision for depreciation: buildings 1.1.20X5 100,000

Provision for depreciation: equipment 1.1.20X5 24,000

Provision for depreciation: motor vehicles 1.1.20X5 51,600

Stock 1.1.20X5 84,912

Sales 1,022,000

Purchases 439,100

Carriage inwards 6,200

Salaries and wages 192,400

Directors’ remuneration 123,000

Motor expenses 3,120

Business rates and insurances 8,690

General expenses 5,600

Debenture interest 15,000

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Debtors 186,100

Creditors 113,700

Bank 8,390

General reserve 50,000

Share premium account 100,000

Interim ordinary dividend paid 35,000

Profit and loss account 31.12.20X4 43,212

2,704,512 2,704,512

The following adjustments are needed:

(i ) Stock at 31.12.20X5 was £91,413.

(ii ) Depreciate buildings £10,000; motor vehicles £18,000; equipment £12,000.

(iii ) Accrue debenture interest £15,000.

(iv) Provide for preference dividend £20,000 and final ordinary dividend of 10 per cent.

(v) Transfer £10,000 to general reserve.

(vi ) Write off goodwill £30,000.

(vii ) Authorised share capital is £200,000 in preference shares and £1 million in ordinary shares

(viii ) Provide for corporation tax £50,000.

You are required to prepare a set of final accounts for FW Ltd