Introduction to Companies Flashcards
Recap of types of profit-focussed business entity (3 types)
Sole traders:
- Personally liable for debts of the business
- People who work for themselves
- Usually small but could employ many
Partnerships:
- Usually personally liable for debts of the business
- Two or more people trading with a view to making a profit
- Risks and rewards are shared
Limited liability companies:
- Personally liability normally limited to amount paid for shares
- Legal entity formed by registration under Companies Act
Accounting and the business entity
- The accounting process of inputting transactions and producing financial statements is the same for all business entities
- May be differences in ________ and ___________ of transactions
Key differences are in the __________ and ___________ requirements
- The accounting process of inputting transactions and producing financial statements is the same for all business entities
- May be differences in volume and complexity of transactions
Key differences are in the presentation and regulation requirements
Company basics
A legal entity formed by registration under Companies Act 2006
Four types:
- Liability is limited by shares
- Public (plc) – can offer securities (shares, loan stock) for sale to general public on a listed stock market; requires minimum net assets of £12,500 - Private (Ltd) – not allowed to offer shares for sale to general public so cannot be listed on a stock market; no minimum net assets required - Unlimited liability
- Liability is limited by guarantee
- Liability is limited by shares and guarantee
Key features of a company
- Legal nature
- Perpetual life
- Limited Liability
- Legal Safeguards
Features: i. Legal Nature (3/2)
- A separate legal entity in the eyes of the law
- Contrast with sole trader - Memorandum and Articles of Association - Incorporated by registration on the Registry of Companies
- Owners = members or shareholders (may be 1 or many)
Features: ii. Perpetual life (2)
- continues after death of shareholders as the shares pass onto their beneficiaries
- Shareholders can choose to end the company & the Courts can force the winding up of the company
Features: iii. Limited Liability (3/1,2)
Shareholders liability is limited
- Owners only lose the amount they invest and any unpaid share capital
Creditors/Payables
- Can not sue the owners directly (veil of incorporation)
- They must sue the company
The company itself has unlimited liability for its debts
Features: iv. Legal safeguards (3)
- Creditors choose to trade with companies at their own risk - credit checks advisable
- There are restrictions on withdrawal of equity by shareholders
- The financial statements are publicly available and filed with Companies House
Sole trader v Company – pros and cons
Advantages (4), disadvantages (3) and both (2) ?
Advantages of Co.:
- Shareholder limited liability
- Transfer of ownership
- Tax
- Kudos / Status
Disadvantages of Co.:
- Higher costs – formation, annual
- Compliance with legislation - CA2006
- Duties of directors
Advantages/disadvantages of Co.:
- Transparency
- Separation of ownership and management
Sole trader v Company – key differences
Ownership interests?
Forms of debt capital?
Profit withdrawn by owners?
Tax on profits?
Ownership interests?
Sole trader
- Capital account
Company
- Equity - Share capital and reserves
Forms of debt capital?
Sole trader
- Bank Loans
Company
- Range of securities
Profit withdrawn by owners?
Sole trader
- Drawings
Company
- Bonus if employee
- Dividends
Tax on profits?
Sole trader
- Liability of sole trader, not the business
Company
- Corporation tax on company profits
Equity
What is it?
Share capital, shown at…?
4 types of reserves
- Term used to include all owners’ capital
- Share capital, shown at nominal value in statements
- Reserves (any other amount attributable to owners)
- Retained earnings - Share premium reserve - Revaluation reserve - Other reserves
Reserves are not a spare pot of money!
Share capital
On the date of incorporation…?
Each share has what?
What can the nominal value be?
3 types of share capital?
- On the date of incorporation, a company will issue ordinary (aka equity) shares to its owners
- Each share has a named value shown on the share certificate
- Nominal value or Par value
- It can be any value: 1p, 2p, 5p, 10p, 25p, 50p, £1 etc.
- Issued (or allotted) share capital – par value of the shares issued to shareholders
- Called up share capital – amount the company has requested to be paid (company may request payment in instalments)
- Paid up capital – the amount actually paid
Share capital - Presentation in the financial statements
Shown where?
Normally..?
If the share capital has not…?
If not all the…then the…?
- Shown within equity on the statement of financial position (SOFP aka balance sheet)
- Normally the issued share capital is fully called up and has been fully paid for – figure in SOFP is the issued = called up share capital
- If the share capital has not been fully called up then the figure for share capital in the SOFP is the called up share capital
- If not all the called up share capital has been paid by the shareholders then the share capital in the SOFP will be the total called up share capital and any unpaid capital is shown as an other receivable within current assets of the SOFP
How do you calculate the number of shares in issue?
divide the share capital figure from the ‘Statement of Financial Position’ by the nominal or par value
If a company has share capital of £200,000 and has shares with a nominal or par value of 50p, then it has 400,000 shares in issue
Quantity of shares X Share’s par value = Share capital
Preference shares
A company can issue preference shares - another form of finance for a company
- These entitle the owner to be paid preference dividends out of company profits before equity shareholders are entitled to any equity dividends
Irredeemable preference shares:
- Company not entitled to buy back (redeem); treat as part of equity
Redeemable preference shares:
- Company is entitled to buy back (redeem); treat as debt
Equity v preference shares
Equity shares:
- Entitled to vote
- Volatile dividends
- Rank last in winding up (risk v reward)
Preference shares
- Normally not entitled to vote
- Fixed dividend
- Rank higher than equity shares in winding up (less risky)
Key points from lecture 2 (3)
Limited companies are…?
Owned by…?
What do these have that contrasts with sole trader and what happens as a result of this?
- Limited companies are a separate legal entity (veil of incorporation)
- Limited companies are owned by their shareholders
- The shareholders have limited liability (contrast with sole traders) therefore more regulation needed to protect investors and creditors
Retained Earnings
What does it represent?
Formula?
Most similar to…?
Fact about this account and what it means?
Retained earnings represent profits that can be paid out as dividends or reinvested into the business
Retained Earnings - all profits - all losses - dividend payments
since the company began trading
MOST similar to sole trader’s capital account
Note: Company Law does not allow dividends to be paid which exceed accumulated profit reserve.
This account cannot go overdrawn which is protection for creditors
Revaluation Reserve
- Revaluation reserve is the holding gain NCAs like land & buildings) are revolved & shown in the SoFP at an amount which exceeds its historical cost. It’s credited to a revaluation reserve account.
Building book value of 100m revalued at market value of 140m
Dr:Non-current assets 40m Cr:Revaluation reserve 40m
Share Premium Reserve
The difference between the market value of the shares and their nominal values is the share premium reserve. There are restrictions such as the shares can be issued but only for more than the nominal value
2.5 mill shares issued with a par value of 25p at a price of £2.20
Total amount raised is £5.5 mill
Dr Bank £5.5 mill
Cr Share Capital (2.5m @ 25p) £0.625mill
Cr Share Premium (2.5m @ £1.95) £4.875 mill
Rights issues vs Bonus issues
What are they? (2,3)
- Rights issues allows existing shareholders to buy shares at discount to the market value as issuing shares to new shareholders is risky & expensive
Company has 30,000 issued shares of 20p each (share capital of £6,000)
1 for 3 rights issue for £1.80 per share (market value of £2.60)
30,000/3 = 10,000 new shares
10,000 @ £1.80 = £18,000
Split between
Share capital (10,000 x 20p par) = £2,000 Share premium (Balance) = £16,000
- Bonus issues allow existing owners to be issued shares in proportion to existing holding, by using share premium and for accumulated profit reserves, but no cash, allowing adjustment of the companies capital structures
5 million issued shares of £1 each and a share premium reserve of £2.3 mill
Decides to make a 2 for 5 bonus issue of shares
(5 mill / 5) x 2 = 2 mill new shares
Dr Share premium £2mill Cr Share capital £2mill
Equity dividends
Amount of dividends is decided by the board of directors, usually quoted in terms of the pence amount each share receives out of the retained earnings. The paid amount is in the SOCIE and no accrual is made
- E.g. a company has 10,000 £1 equity shares in issues and during the year paid a dividend of 5p per share. Total paid = £500
Preference Dividends (4)
It is usually expressed as a fixed percentage and is paid before equity divdends
Irredeemable preference dividends are paid from retained earnings reserve like equity dividends
Redeemable preference dividends are treated as finance cost like interest and deducted through IS
- Record the dividend due for the period, making accrual if required
- A 7% preference share with a par value of 50p will receive a dividend of 3.5p per year
Forms of debt capital
What does a company have access to?
What do these securities have?
What happens to interest?
What are a form of debt capital?
What is it accounted for under?
- A company has access to bank loans and can also borrow in the form of debt securities (eg loan stock, debentures)
- These securities often have a par value, interest payments and a redemption date
- Interest (paid and accrued) is a finance cost in Income Statement
- Redeemable preference shares are a form of debt capital
- Accounted for under IFRS9 Financial Instruments
Forms of debt capital 2
What are loan stocks and debentures?
When is interest paid?
What can it be? (2)
- Loan stock and debentures (aka corporate bonds) are effectively loans to the company that carry a fixed rate of
interest based on the nominal value and usually repayable at some future date. - Interest paid ahead of dividends
- Can be secured (fixed charge on specific asset or floating charge on group of assets) or unsecured.
- Can be convertible (at the option of the holder) into equity shares at some point in the future
Tax
A company is a…
What is tax therefore?
As tax liability is finalised after the year end…?
Double entry for this?
Any under/over provisions are…
During year….
- A company is a separate legal entity and is liable to pay corporation tax on its profits
- Tax is therefore another expense in the Income Statement
- As the tax liability is finalised after the year end, estimated tax liabilities are calculated and included within current liabilities
- Dr tax charge (IS), Cr tax payable (SOFP) with estimated liability
- Any under/over provisions are corrected in the following year
- During year, record tax paid and record year end estimated liability
Tax - 2 methods?
Method 1:
1.Post tax paid in year to the tax liability and adjust for any under or over provision in the previous year
2.
over provision:
Dr tax payable Cr Tax charge/expense
under provision:
Dr tax charge/expense Cr tax payable
Method 2:
- Clear the opening tax liability to the tax charge/expense account
Dr tax liability Cr tax charge/expense
- Post tax paid to the tax charge/expense account
Dr tax charge/expense Cr Bank
- Post estimated year end liability
Dr tax charge/expense Cr tax liability
don’t have to calculate the under or over provision as it automatically comes through in the tax charge account
Tax Example (4 double entries)
Estimated tax liability in y1 to be £25,000 as at 31 March 22 but paid no tax in that year. During the year end 31 March 23 they paid the tax liability of £22,000 for the year ended 31 March 22. The company estimates its tax liability for year end 31 March 22 as £30,000
· y/e 31 March 2022
Dr tax charge IS £25,000 Cr tax payable SOFP £25,000
Being estimated tax liability for ye 31.3.22
y/e 31 March 2023
Dr tax payable SOFP £22,000 Cr Bank £22,000
Being tax paid in the year
Dr tax payable SOFP £3,000 Cr tax charge IS £3,000
Being over provision y/e 2022
Dr Tax charge IS £30,000 Cr tax payable (SOFP) £30,000
Being estimated tax liability for ye 31.3.23
Key points (9)
- Companies are owned by their shareholders who hold shares
- Various types of shares (ordinary, preference) with rights
- Equity (capital and reserves) theoretical amount due to owners
- Owners entitled to share of profits in the form of dividends
- Shares are issued at a nominal or par value
- Shares may be issued at a premium (but never a discount) to par
- Non-current assets may get revalued
- Companies have access to debt capital as a form of finance
- Companies are liable to and must account for corporation tax
