2. Introduction to limited company financial statements

Question 1

Sub-classification of equity

Answer 1

• Funds contributed by shareholders
• Retained earnings or profit
• Other reserves

Question 2

Equity sections in SFP

Answer 2

+ Issued share capital
(Capital reserves:)
+ Share premium
+ Revaluation surplus
(Revenue reserves:)
+ Retained earnings

Question 3

Ordinary shares characteristics

Answer 3

• Most common type of shares.
• Have voting rights.
• The shareholder gives funds to the entity in exchange for a share of the business.
• Risks: if the company does not make a profit, it will not pay dividends. If the company goes into liquidation, shareholders are the last to be paid.
• Potential reward: the shareholder may receive a dividend or share of the profit.

Question 4

Preference shares characteristics

Answer 4

• Shareholders have an agreement and will be paid a fixed dividend in each year of profit, based on the nominal value of the share, before dividends are paid to ordinary shareholders.
• Do not have voting rights.
• Cumulative preference shares can carry the right to a dividend forward so that dividends missed are paid in later years.
• In the event of liquidation of the business, preference shareholders receive their stake in the business before ordinary shareholders, but still after all other liabilities have been paid.

Question 5

Nominal value of shares (or par value)

Answer 5

• Value entered in the accounts.
• Different to market value (price at which shares are traded).
• Different to issue price (price at which shares are issued to shareholders by the company).

Question 6

Rights issue (of shares)

Answer 6

• Raising of cash by offering shares to existing shareholders, in proportion to their existing holdings.
• Usually sold at a discount to the market value.
• Companies use rights issues because it is cheaper than offering shares to the entire public.

Question 7

Bonus issue

Answer 7

• The capitalisation of reserves (either capital or revenue) in the form of free shares issued to existing shareholders in proportion to their holdings.
• No cash flows into the company
• One of the few uses of capital reserve (which cannot be used to fund payment of dividends)
• Reduce share premium and increase share capital.

Question 8

Capital reserves

Answer 8

• Revaluation surplus + Share premium
• Created as a result of non-trading activities.
• Capital reserves cannot be used to fund dividend payments (they are non-distributable)

Question 9

Revaluation surplus/reserve

Answer 9

• Usually the result of a revaluation of land, property or other assets.
• The new value of the asset is shown in the non-current assets section of the statement of financial position.
• The amount of the revaluation (increase in value) is recorded as other comprehensive income and in a revaluation surplus on the SFP.

Question 10

Share premium

Answer 10

• When a company issues additional shares at a higher amount than the nominal value.
• The nominal amount is recorded in the issued share capital section and the extra amount is recorded in the share premium section.

Question 11

Revenue reserves

Answer 11

• Profits generated from trading activities that have been retained by the company instead of being distributed to shareholders.
• Are distributable.
• Includes retained earnings from the statement of changes of equity.
• General reserve or specific (replacement of equipment)

Question 12

Statement of changes in equity

Answer 12

Retained earnings:
+ Balance at the start of the year
+ Profit for the year
+ Transfers from other reserves
- Dividends paid within the year
- Transfers to other reserves
= Balance at the end of the year.

Question 13

Statement of changes in equity definition

Answer 13

It is effectively a reconciliation statement of the different elements of equity.
Shows how equity of the business has changed between periods

Question 14

Dividend payments

Answer 14

• Distributions to holders of equity claims as a return on their investment.
• Dividends paid out will be shown in the statement of changes in equity.
• The details of what has been paid out as dividends will be shown in the notes to the accounts.

Question 15

Loans and debentures

Answer 15

• If the business wants to raise funds without issuing more shares, it may take out loans or issue debentures.
• Loan and debentures are shown in the statement of financial position as non-current liabilities.
• Loan and debentures interest is shown in the statement of profit and loss under Finance Costs.

Question 16

Loans

Answer 16

Monies borrowed by the company from lenders on a medium or long-term basis.

Question 17

Debentures

Answer 17

Formal certificates issued by companies raising long-term finance from lenders and investors, commonly secured against assets such as property.
May also be referred to as ‘loan notes’ or ‘loan stock’.

Question 18

STATEMENT PROFIT AND LOSS (layout)

Answer 18

+ Revenue
- Cost of sales*
= Gross Profit
- Distribution Costs
- Administrative expenses
= Operating Profit
- Finance Costs
= Profit before Tax
- Tax
= Profit for the year from continuing operations
+ Other Comprehensive income for the year
+ Revaluations
= Total Comprehensive income for the year

• Cost of Sales = Opening Inventories + Purchases - Closing inventories

Question 19

STATEMENT CHANGES IN EQUITY (Retained Earnings)

Answer 19

Retained Earnings*:
+ Balance at the start of the year
+ Profit for the year
- Dividens
= Balance at the end of the year

Question 20

STATEMENT FINANCIAL POSITION (layout)

Answer 20

ASSETS:
Non-Current Assets:
+ Intangible
+ PPE
Current Assets:
+ Inventory
+ Trade and other receivables
+ Cash and cash equivalents
= Total Assets

EQUITY AND LIABILITIES:
Equity:
+ Issued share capital
+ Share premium
+ Revaluation surplus
+ Retained earnings*
= Total equity
Non-current liabilities:
+ Debenture / Loan
Current liabilities
+ Trade and other payables
+ Tax liabilities
= Total liabilities
= Total equity and liabilities