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OLevel

Accounting - 7707

Limited Companies

Paper-2

Limited Companies

Limited Companies:

Limited companies are incorporated businesses. They are owned by the shareholders and controlled by the directors, appointed by the shareholders at the annual general meetings. When the company comes into existence it must be registered through the registrar of the company which if accepted will be incorporated into a limited liability company. limited companies are also called limited liability companies because the liability of the shareholder is limited that is, they are not personally liable for the debts of the company in case of insolvency or bankruptcy. In case of insolvency, the maximum amount that can be snatched from them is limited to their interest. when the company comes into existence it must prepare two documents:

1. Memorandum of association
2. Articles of association

Memorandum of Association: 

It is the relation of the company to the outside world and the contents of the memorandum of association are as follows:

1. The name of the company ending in either PLC or ltd. (name clause)
2. A statement that the liability of the company is ltd. (limited clause)
3. Amount of authorized share capital (capital clause)
4. The address of the registered office (location clause)
5. The principal activities that a company will be involved in. (activity clause)

Articles of Association: 

They are the internal rules governing the rights of the members and the running of the company. The contents are as follows:

1. It defines the rights and duties of the shareholders
2. It defines the rights and duties of the directors.
3. It contains the regulations as to how the meetings may be called
4. It defines the rules regarding the voting rights
5. It contains the rules regarding the member who fails to pay the amount due upon them
6. The minimum qualification to be a director
7. The minimum number of shares a director should hold

Categories of a Company:


1. Private limited companies
2. Public limited companies

Private limited companies: 

They are usually family-owned businesses. They cannot have an authorized share capital of more than 50000. They cannot issue shares to the general public, nor are their shares traded in the stock exchange. Private limited companies always have ltd. attached to its name.

Public limited companies: 

They can issue their shares to the general public and their shares can be traded in the stock exchange. Their authorized share capital must be more than 50000. They work under the policy of IAS and companies act 1985 and companies act 2006. They usually have a word, plc attached to their name.

The capital structure of a company comprises ordinary share capital, preference share capital, debentures, convertible loan stocks, and reserves.

Ordinary shareholders: 

They are the real owners of the company and have a voting right with which they take an active part in the running of the business, by appointing the directors, and hence they are the risk bearers. At the time of distribution of dividends, the ordinary shareholders are given the last priority, and even in the case of insolvency, they rank last after the payments have been made to the creditors, long-term liabilities, and preference shareholders. The number of dividends that they receive is not fixed and varies as per the probability of the company. In years of low or no profit, they are not given any dividends at all.

Preference shareholders: 

They are given preference over ordinary shareholders both at the time of distribution of dividends and in case of insolvency. They usually don’t have a voting right and they receive a fixed rate of dividends and are divided into four categories:

1. Cumulative preference shares
2. Non-cumulative preference shares
3. Participating preference shares
4. Non-participating preference shares

Cumulative Preference Shares: 

The shares that will receive the dividends whether the company is making profits or not. In case the company is not able to pay the dividends in one year because of low profitability, then the amount that is not paid is to be compensated in the next year and until the amount is paid it will be treated as current liabilities.

Non-Cumulative Preference Shares: 

The shares will receive a fixed rate of dividends only in the year when the company is making good profits. In years of low profits, they will only receive the dividends which the company will be able to pay and the right over the remaining dividends will be lapsed and will not be compensated in future years.

Participating Preference Shares: 

The preference shares have a voting right and they take part in running the business by choosing the directors of annual general meetings. Amongst the preference shares, they rank last both at the time of distribution of dividends and in case of insolvency.

Non-Participating Preference Shares: 

The preference shares who neither have voting rights nor are cumulative.

Debentures: 

These are the (IOU) I owe you a certificate of the company, they are the long-term liabilities on which a fixed rate of interest is charged and are usually secured against mortgages and the amount owed by the company is to be returned on maturity. The interest on debentures is not the distribution of profits, instead are the expenses of the company.

Preference shares are also divided into broader categories: 
They are redeemable preference shares and non-redeemable shares.

Convertible loan stocks are the long-term liability of the company on which a fixed rate of interest is given. There are two types of reserves: revenue reserves, capital reserves.

Revenue reserves are the amounts set aside by the company from the trading activities of the business that is from the profits for the prospects of the company. the revenue reserves of the company comprise of: 

1. General reserves
2. Asset replacement reserves
3. Retained profit

General reserve: 

The amounts that the company set aside for the purpose of expansion or to combat a problem that might arise in the future.

Retained earnings: 

The leftover profits are ploughed back into the company to finance the running of the company in an effective manner. It is the cheapest source of finance.

Asset replacement reserve is not part of the syllabus.

Capital reserves are those which are generated through non-trading activities and they comprise of: 

1. Share premium
2. Revaluation reserve
3. Capital redemption reserve

Authorized share capital is the maximum amount of shares that the company is allowed to issue.

Issued share capital is the part of the authorized share capital which the company has already issued to the general public.

Called up share capital is the part of the issued share capital that the company has asked to pay.

Uncalled-up share capital is that part of issued share capital that is yet not been asked to pay.

Paid-up share capital is the part of called-up share capital that has already been paid.

Face value is also known as nominal or par value. It is that amount of share which is written on the face of the shares.

The issue price is the number of shares at which the shares are offered to the general public.

Share premium is the difference between the issue price and the face value of shares and is the amount that is generated by selling a share at a higher price than its face value.

Amount of shares= Face value * Number of shares

Market value is the price at which the share is being traded at the stock exchange. Dividends are the distribution of profits that are paid to the shareholders if the dividends are paid during the year, they are called the interim dividend and if dividends are paid or proposed at the end of the year then they are called the final dividend.

Dividends can be distributed either as dividends per share or as a rate of dividend. Dividend per share is applied to the number of shares whereas the rate of dividend is applied to the amount of shares.

The accounting treatment of questions involving companies comprise of preparation of:

1. Income statement
2. Statement of changes in equity
3. Statement of financial position

Information regarding the income statement is given in earlier chapters and is going to be made in the same way.

Income Statement:



STATEMENT OF CHANGES IN EQUITY:

Equity comprises ordinary share capital, preference share capital, share premium, revaluation reserve, general reserve, and retained earnings. But in the course of CAIE revaluation reserve is not used at this stage. any movement in any of these things such as profits made, dividends paid, transfer to reserves, and the issue of shares are all part of the statement of changes in equity. Proposed ordinary dividends are not part of this statement but paid are. This was previously termed as a profit and loss appropriation account.


STATEMENT OF FINANCIAL POSITION:

Statement of financial position in companies is made as normal except for equity section in which details of all closing balances of a statement of changes in equity are to be incorporated.

In most of the questions, you are to make a statement of changes in equity and extract it from the statement of financial position.
Preference share dividends are also subtracted from the profit and loss account in the income statements. After all, the expenses are deducted the profit obtained is called the distributable profit.


Following is an example to get you familiarized with the addition in the accounts and statements:

Example#1: The share capital of A town ltd. on 31 December 2020 is as follows:

The following information is available for the year ended 31 December 2020:

The directors resolved that:
(i) $50,000 should be transferred to the general reserve
(ii) The final preference dividend should be paid
(iii) A final dividend of 5c per share should be paid to the ordinary shareholders.
REQUIRED:
(a) The statement of changes in equity for the year ended as of 31 December 2020.
(b) A statement of financial position extract on 31 December 2020 showing the details and the total of shareholders funds only.


SOLUTION:

(a) Statement of changes in equity as of 31 Dec 2020

 (b) Statement of financial position as of 31 December 2020:

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