Chapter 15 Company financial statements Flashcards
1.1 Limited liability companies
- Separate legal entity: limited company is a separate entity and is distinct from its owners in the law. A sole trader is legally not separate but is treated so for accounting purposes
- Liability: a company is liable for its debts, the owners of the company are only liable for amounts they have not paid yet for their shares, shareholders have limited liability. For sole traders they are personally liable for any debts
- Ownership and management: a company is owned by shareholders; managers of the company are called directors and are appointed by shareholders (directors can also be shareholders). Sole trader is generally both the owner and manager of the business
- Formalities: companies require public availability of financial statements and an annual audit, sole traders do not
A private limited company has shares not available to the general public, a public company is available to the public and can be listed on a stock market.
1.2 Company published accounts
IAS 1 incorporates the recommended formats for company published accounts. A statement of financial position, statement of profit or loss, statement of changes in equity, statement of cash flows and notes in the accounts are required.
Statement of profit or loss:
- Revenue: this is income arising from the ordinary activities of an entity. Recognised when the entity has transferred the promised goods or services to the customer. IFRS 15 sets out 5 steps for the recognition of revenue. Identify contract with customer, identify separate performance obligations, determine the transaction price, allocate the transaction price to the performance obligations, and recognise revenue when a performance obligation is satisfied.
- Expenses: classified under three headings. Cost of sales (cost of the goods or service sold), distribution costs (expenses relating to selling or delivering of product or service) and administrative expenses (all expenses not classified above). Depreciation and salaries can be split across all three categories
- Income tax: a company shows a tax expense which a sole trader does not. This is because the company is a separate legal entity and has its own tax liability.
Cost of sales: purchases plus carriage inwards adjusted for opening and closing inventory, and any losses of inventory. In a manufacturing company wages of production staff and maintenance and depreciation expenses of production of non-current assets plus losses on their disposal are also included.
Distribution costs: wages of marketing and distribution staff, sales commission, vehicle costs, depreciation of motor vehicles used for distribution and marketing costs. Depreciation of other non-current assets used by distribution operations and loss on disposal of these assets.
Administrative expenses: wages of administrative staff, deprecation of non-current assets used by these individuals. Amortisation of intangible assets, expenses of substantial loss of inventory and irrecoverable debts expense.
2.1 Statement of financial position – ordinary share capital
Ordinary shareholders own the share capital and reserves of the company, so are included as equity in the statement of financial position, voting rights are attached to the shares and they may receive dividends. Ordinary dividends are expressed in terms of pence per share. No dividend may be paid on ordinary shares until the preference share dividend has been paid in full.
2.2 Statement of financial position – preference shares
Preference shares do not generally carry voting rights, they receive a fixed dividend as a % of the nominal value and is paid in priority to ordinary dividends. They are redeemable preference shares which specify that they are repayable by the company and as classified as debt not equity in the statement of financial position. Dividends are classified as finance costs in the statement of profit or loss. Irredeemable preference shares mean the company is not entitled to buy them back. They are classified as equity.
2.3 Share capital values
Each share has a nominal or par value. Shares are issued by the company at an issue price, this is at least equal to the nominal value but often exceeds it. The market value of a share changes according to success. If a company is listed on the stock exchange the value is determined by recent transactions. This value does not feature in the financial statements.
2.4 Issue of ordinary shares
A company issues shares generally above par (nominal value). The double entry to record this is:
- Dr Cash (issue price x shares)
- Cr Share capital (nominal value x shares)
- Cr Share premium (excess over nominal value x shares)
Both the share capital and share premium accounts are shown on the statement of financial position within the equity section.
2.5 Rights and bonus issues
A rights issue is the offer of new shares to existing shareholders in proportion to their existing shareholding at a stated price (typically below market value but always above nominal value). This is accounted for the same way as a typical share issue.
A bonus (or capitalisation or scrip) issue is the issue of new shares to existing shareholders in proportion to their existing shareholding. No cash is received. The issue is funded from reserves, any reserve can be used, though a non-distributable reserve such as the share premium account is used in preference to distributable reserves. Should the share premium balance be insufficient, any excess is used from retained earnings.
- Dr Share premium (nominal value)
- Cr share capital (nominal value)
2.6 Share capital terminology
- Authorised share capital is the nominal value of the maximum number of shares a company can have in issue at any particular point in time
- Issued share capital is the nominal value of the shares actually issued to shareholders
- Called up share capital is the amount of nominal value of the issued share capital which has been requested from shareholders. This is shown on the statement of financial position for the company
- Paid up share capital is the amount of the nominal value of the called up share capital that has been paid by the shareholders. Any differences between called up and paid up are a receivable on the company’s statement of financial position.
2.8 Statement of financial position – Equity
Calculation is the ordinary share capital plus irredeemable preference shares plus share premium plus retained earnings plus general reserve.
Retained earnings includes all the retained profits of the company up to the statement of financial position date. The balance is retained earnings b/f + net profit – dividends. This is then carried forward. We do not include dividends on redeemable preference shares as these are deducted from profits in the statement of profit or loss as finance costs.
General reserve: this reverse is an extension of retained earnings. A company may choose to transfer some of their retained earnings into a separate general reserve.
2.9 Statement of changes in equity (SOCIE)
This shows how the balances making up equity in the statement of financial position have changed over the year. movements include profit in the year, dividends paid (on ordinary and irredeemable preference shares), transfers between reserves and share issues
2.10 Issue of long term liabilities
A limited company can raise funds by issuing loan notes (as called bonds or debentures). A loan note is a document that is evidence of debt. A person will buy a loan note for a set nominal value, they are effectively loaning money to the company. The double entry is Dr Cash Cr Non-current liabilities.
The nominal value of the loan note will be repayable after a certain number of years. The loan note holder will receive an annual fixed amount of interest based on the nominal value (referred to as a coupon rate). The interest incurred is included in finance cost in the statement of profit or loss. The double entry to record the interest is Dr Finance cost Cr Cash / accrual
2.11 Provision and allowances
According to IAS 37 a provision is a liability to a third party, where either the amount or the timing of the payment is not yet certain. For example, warranty claims, refunds for returned goods and litigation. Judgement will be used to determine the best estimate of the provision. In order to recognise a provision, the liability needs to represent a present obligation to incur the expenditure and it is probable more than 50% likely) that the expenditure will be incurred.
Allowances such as the allowance for irrecoverable debts are adjustments to the value of an asset. They are not liabilities and should not be referred to as provisions.
The double entry to record a provision is: Dr Relevant expense account Cr provision (statement of financial position)
When the expenditure is incurred: Dr Provision (SoFP) Cr Cash at bank
If the expenditure is not the same as the amount provided any difference is taken to profit or loss as either an expense (actual expenditure exceeds provision) or income (actual expenditure is less than provision).
3.1 Tax in company accounts
Accounting for tax is initially based on estimates since a company’s tax bill is not finalised and paid until after its year end. A company will normally under or over provide for tax in any given year. At year end a company calculates its net profit, it then estimates its tax liability, the company accounts for the tax liability: Dr Tax expense (SoPL) Cr Tax payable (SoFP)
After the year end the company then pays the tax bill: Dr Tax payable Cr Cash
If the payment is more than the liability estimated and we have under provided tax: Dr Tax expense Cr Tax payable
If the payment is less than the estimated liability we have over provided: Dr Tax payable Cr Tax expense
2.2 Tax ledger accounts technique
Bring in the opening balance on the tax payable ledger account (last years estimated liability). Record cash paid to HMRC. Usually this is different to the estimate, transfer this under/over provision to the tax expense ledger. Record this year’s tax estimate in the tax payable and tax expense ledger accounts (this is the closing liability). Close of the tax payables ledger account (SoFP) and close off the tax charge ledger account (SoPL). The statement of profit or loss charge will consist of the tax liability for the year + under/(over) provision in prior year.
