Company Final Accounts

A Limited liability company is an organization owned by its shareholders, whose liability is

limited to its share capital. In other words, limited liability company is business whose owner’s
liability for the business’s debts is limited to the amount of money that they invested in shares in
the business, so their personal possessions cannot be lost.
Limited liability companies came into existence because of the need for businesses to raise
capital and at the same time to give the investors a degree of security. They appeared when
businesses found the need to raise large amounts of capital.
A person who invests capital in a limited liability is a shareholder. Shareholders are the owners
of a limited company.

The following table shows the difference between a sole trader, and a partnership and a limited
company.
Sole trader Partnership Limited company
One owner Two or more owners No limit on number of
shareholders
Unlimited liability Unlimited liability Limited liability
Sole trader has all the risk Risk is shared between the Risk is limited to the amount
partners according to their invested in shares.
partnership agreement
Sole trader is entitled to all of The profits are shared among Shareholders receive a
the profits. the partners dividend as their share of
profits.
Sole trader does not have Partnership does not have Limited company has separate
separate legal entity separate legal entity legal entity.
Sole trader is not required to Partnership is not required to Limited company must have
have an audit or publish have an audit or publish an audit and publish accounts.
accounts accounts.
Sole trader has full Responsibility of running Company run by directors
responsibility for running the partnership dividend between who are not necessarily the
business the partners shareholders
Internal capital is from sole Internal capital is from each Capital is raised on the issue
trader partner; each new partner of shares
brings extra capital
Ideas and workload are Ideas and workload are shared Directors are appointed by
limited to the sole trader among partners shareholders to have the ideas
and to take on the workload

Shares

The capital of a limited company is divided into small units called shares. The value of a share in
a limited company could be as low as £0.50, but £1 share are more typical, and shares with other
nominal values are possible. To be a share holder of a limited company, a person must become
a shareholder by buying one or more of the available shares.

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Private companies (Ltd) sell shares to known individuals, such as family and friends, whereas
public limited companies (plc) sell their shares to general public. Public limited companies tend to
be larger than their private limited companies as they can raise more funds from a wider range of
people.

Many people invest in shares not for the dividend, but for capital growth. If shares are issued at
their nominal value, they are referred to as issued at par. If shares are issued at a higher price than
the nominal value a share premium is created. Both the nominal value and share premium are
shown in the financial statements. Capital growth is achieved if the shares are sold for a higher
market price than their original purchase price.

When a company is formed, the maximum number of shares that can be issued is referred as the
authorised share capital, whereas the number of shares actually issued as referred to as the
issued share capital.

Ordinary Shares

Ordinary shares are the most common type of share issued. An ordinary shareholder receives a
variable dividend based on the level of profit, but if there is insufficient cash or profit, or both then
dividends do not have to be paid.

Each share represents one vote at the annual general meeting (AGM), so the more shares a
shareholder owns, the greater the control. Various decisions are voted on at the AGM, including
the rate of dividend.

Preference Shares

Preference shareholders have preferential right to dividends over ordinary shareholders and so
receive their dividend before ordinary shareholders. As they are more likely to receive a dividend,
they are seen as holding the shares with lower risk. However, the amount of dividend that they
receive is at a fixed percentage of the nominal value of their investment, so in periods of high
profits it is possible that their dividend will be lower than that paid to an ordinary shareholder.

Preference shareholders are not entitled to vote at the AGM and are therefore seen as having less
control than ordinary shareholders. The shares will be either cumulative preference shares or
non-cumulative preference shares. If dividends are not paid in one year due to lack of funds
or profits, then in the case of cumulative preference shares the shareholders carry forward their
right to the dividend to the next year, and so on until the accumulative dividend rights can be paid.
Non-cumulative preference shares do not have this advantage.

Redeemable preference shares can be bought back by the company if allowed by the Article
of Association (e.g. 8%nredeemable preference shares 2016 can be bought back in 2016).

EXAMPLE:

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ISSUE OF SHARES

Serandib Ltd. has authorised share capital of 200 000 ordinary share of £1 each and 100 000 8%
preference shares of £2 each.

The company decided to issue 100 000 ordinary shares at £1.30 and 50 000 8% preference shares
at £2.20. these shares are fully subscribed and paid up.

Required:
Show the journal entries to record the issue of ordinary shares and preference shares.
Show the entries in the ledger accounts?

The Journal
Debit (£) Credit (£)
Bank (100 000 x £1.30) 130 000
Ordinary Shares 100 000
Share Premium 30 000
Bank (50 000 x £2.20) 110 000
Preference Shares 100 000
Share Premium 10 000

Bank Account
Date Detail £ Date Detail £
Ord. Shares 130 000
Preference Sh 110 000

Ordinary Shares Account

Date Detail £ Date Detail £
Bank 100 000

Preference Share Account

Date Detail £ Date Detail £
Bank 100 000

Share Premium Account

Date Detail £ Date Detail £
Bank 30 000
Bank 10 000

Extract SOFP

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 Share Capital & Reserves £

Ordinary Share Capital 100 000

Preference Share Capital 100 000
Share Premium 40 000

Bonus Issue

Companies may use their reserves to issue bonus shares to their ordinary shareholders in the ratio
of their existing shareholding. These shares are issued with no payment required by the
shareholders since they already own the reserves of the company. A bonus issue is a way of
releasing reserves to the shareholders without the impact on cash flow that would occur if a
dividend were declared, since no cash flows into or out of the company.

Either capital reserves or revenue reserves can be used to issue bonus shares, but companies will
use capital reserves first, as this is one of the few uses allowed for capital reserves.

The effect of issuing bonus shares is that the share capital will increase on the statement of financial
position by the amount of shares issued. While reserves will decrease by the same amount. The
rest of the statement of financial position will remain the same as before the issue.

Example:
A company’s statement of financial position at 31 December 2014 is:
$000
Non-current assets 1550
Net current assets 250
1 800
Equity
Ordinary shares of $1
each 1 000
Share premium 400
General reserve 250
Retained earnings 150
1 800

The directors decided to issue bonus shares on the basis of one share for every two ordinary shares
held.

Required:

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Show the journal entries and SOFP after the issue of bonus shares.

THE JOURNAL
Debit (£) Credit (£)
Share Premium Account 400 000
General Reserve Account 100 000
Bonus Share Account 500 000
Bonus Share Account 500 000
Share Capital Account 500 000

SOFP

$000
Non-current assets 1550
Net current assets 250
1 800
Equity
Ordinary shares of $1 each 1 500
General reserve 150
Retained earnings 150
1 800

RIGHT ISSUE
The purpose of rights issue is to raise further finance for the company. A rights issue offers existing
shareholders the opportunity to purchase additional shares at a price slightly below the current
market price. Right issue is made to the shareholders in proportion to their current shareholding.
The shareholder has the option of either taking up and paying for the shares offered or,
alternatively, selling the rights on the stock market.

A company’s statement of financial position at 31 December 2020 is:

$000
Non-current assets 1 100
Net current assets 100
1 200
Equity
Ordinary shares of $1 each 600
General reserve 350
Retained earnings 250
1 200

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The directors wish to raise additional finance and offer shareholders a rights issue of one additional
ordinary share for every three shares held at a price of £1.25.

Required:
o Prepare journal to show entries of right issue.
o Prepare the SOFP to show the changes after the right issue of shares.

THE JOURNAL
Debit (£) Credit (£)
Bank Account 250 000
Ordinary Share Capital Account 200 000
Share Premium Account 50 000

$000
Non-current assets 1 100
Net current assets 350
1 450
Equity
Ordinary shares of $1 each 800
Share Premium 50
General reserve 350
Retained earnings 250
1 450

The Reserves of a Limited Company

There are two types of reserves:

Revenue Reserves

Revenue reserves are those reserves that are created by transfer from profits made the company.
Non-current asset replacement reserve is created for a specific purpose such as replacement of
non-current assets or major repair work that the directors are aware of. General reserve is
maintained by the company, that has no specific purpose but retained profit in the company for
any future use. Undistributed profit of the company is called retained profit which is also a revenue
reserve.

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 Double Entry for General Reserve
Retained Earnings Debit
General Reserve Account Credit

Double Entry for Non-current Asset Replacement Reserves

Retained Earnings Debit
Non-current Asset Replacement Reserve Credit

Capital Reserves

Capital reserves are created as a result of non-trading activities and are not available for
distribution to the shareholders in the form of dividends. They cannot be transferred to the income
statement.

The common capital reserves are:

o Share Premium
o Revaluation Reserve
o Capital Redemption Reserve

Item Debit Credit

Share premium Bank Share premium account
Revaluation reserve Asset account Revaluation account
Capital redemption reserve Reserve account Capital redemption account

Interim and final dividend

Preference shareholders receive a fixed rate of dividend. The total amount paid for preference
shareholders cannot exceed the fixed rate, so it does not matter to a preference shareholder if there
is an interim dividend as well as final dividend because these two dividends will equal the fixed
rate. However, an ordinary shareholder can receive two dividend payments that are totally
ndependent of each other and for which there is no maximum.

Calculation of Dividend
The dividend to be paid on ordinary shares can be calculated in different ways.

Example:

Share details Rate Calculation of dividend

100,000 ordinary shares of £1 each 6% (£100,000*6%) = £6,000
100,000 ordinary shares of £1 each 8p (£0.08) (100,000 * £0.08) = £8,000
£200,000 ordinary shares of £0.50 each. 2p (£0.02) (£200,000/£0.5) * £0.02 = £8 000
200,000 8% preference shares of £1 8% (200,000 * £1) * 8% = £16,000

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Double entry for dividend

Interim dividend -
Retained earning - Debit
Bank - Credit

Final dividend -
Retained earning - Debit
Bank - Credit

Debentures
Many limited companies raise additional capital by issuing debentures. Debentures are long-term
loans to the company. A denture is the legal document issue by the company that is managing the
debt. Debentures are generally secured against the company’s assets. The security may be fixed,
that is it relates to specific asset or group of assets, or it may be floating charge where no specific
assets are identified. If the company were to be wound up, the debenture holders would be in a
safer position than either the preference shareholders or the ordinary shareholders because of this
security.

Like all forms of borrowings, the debt has to be serviced and the interest due will usually be paid
half yearly. The interest that the company pays to the holders of the debentures, like all interest
payable, is a charge against the profits and appears as an expense on the profit and loss account.

Different Types of Fixed Assets

Intangible assets - these are non-physical assets, i.e. assets that cannot be seen or touched.
Example includes patent and brand names, e.g. Coca – Cola etc.

Tangible assets – these are physical assets, i.e. those that can be seen and touched, e.g. delivery
vehicles etc.

Investments - If investments are to be kept for a number of years they are treated as fixed
assets. However, if the intention is to sell the investments within the current year, they would be
classified as current assets.

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Director’s Report
This is rather like a school or a collage report in that it outlines the progress over the past year and is also
it looks towards the performance of the future.

• A review of performance during the year

• The position of the company at the end of the year.
• The main activities of the company during the year plus major changes in the activities that may
have taken place during the year.
• Important changes to fixed assets that have taken place during the year.
• Particulars of important events affecting the company since the financial year end.
• An indication of any likely future development undertaken by the company.
• An indication of research and development undertaken by the company.
• Amounts of recommended dividends and transfers to the reserves
• Name of people who were or are directors during the year.
• The number of shares and debentures in the company held by the directors.
• Any charitable donations or donations to political parties if these donations exceeds $200
• Information regarding the health, safety and welfare of the employees while at work
• If the company employees more than 250 people, a statement on the policy regarding the
employment of disabled people.

Auditor’s Report
This is a report addressed to the shareholders, not to the directors.

• The company keeps proper books of account

• Proper records are kept.
• The final accounts are in agreement with the records kept.
• The auditors must report on whether, in their opinion:
• The balance sheet and profit and loss account have prepared in accordance with the requirements
of the Companies Act.
• The profit and loss account gives a ‘true and fair view’ of the profit or loss for the financial year.

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