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Introduction to Financial Accounting > Limited Companies > Flashcards

Limited Companies Flashcards

1
Q

What are the Types of Business Entity?

A

Sole Trader
-an unincorporated business with one owner,
-not a separate legal entity
(owner personally liable for all business debts

Partnership

  • more than one owner
  • partners jointly liable for business debts

Limited Liability Partnership
-some feature of partnerships and LTD Co.

Limited Company
-a legal entity which has a separate identity from its shareholder owners
-limited liability
(less likely to invest in risky enterprise)

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2
Q

Sole Trader Vs Limited Company

A

Sole Trader

  • no separate legal entity
  • owner management
  • owner remuneration- aka drawings (not an expense, reduced capital)
  • manager remuneration (if manager not owner, expensed as wages)
  • limits to liability = unlimited liability for owner

Limited Company
-separate legal entity
-shareholders own business and appoint directors to run it
-not entitled to remuneration
(receive dividends to reduce equity but not profit)
-liability is limited to amounts invested

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3
Q

Sole Trader Vs Limited Company - owners equity

A

Sole Trader
Capital account = capital introduced + profit for year - drawings at year end

Company
Equity = ordinary share capital + retained earnings (profit for the year - dividends paid)

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4
Q

Public vs Private companies

A

Public companies (plc)

  • raise capital from public at large
  • shares may be listed on the Stock Exchange or other markets (IPO- initial public offering)
  • must have issued capital >50,000

Private
-any other limited company

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5
Q

Sole trader vs Limited company - accounting requirements

A

Sole Trader
-no legal requirements regarding format

Companies

  • legal requirement for some form of publically available accounting information
  • UK listed companies have to comply with IFRS

Unlisted Companies
-reduced requirements laid down in UK GAAP

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6
Q

Types of Share Capital

A

Ordinary / equity (US - common stock)

Preference. (US- preferred stock)

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7
Q

What is ordinary share capital?

A
  • ordinary shareholders are owners of the company
  • vote attached
  • no entitlement to dividend
  • riskier investment
  • if the company grows the value of shares increases
  • retained earnings belongs to equity
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8
Q

What is preference share capital?

A
  • lenders
  • no vote
  • entitlement to fixed rate dividend
  • less risky investment
  • no capital gains as no participaton in surpluses
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9
Q

Types of preference share

A
  1. redeemable preference shares-
    - treated as non-current liability = common
  2. convertible preference shares
    - option to convert to ordinary shares at a future date
    - part liability/ part equity
  3. Irredeemable preference shares
    -part of equity
    =rare
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10
Q

What is authorised share capital

A

the maximum amount of share capital which can be issued (disclosed in accounts)

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11
Q

Define Nominal value

A

the initial (par) value at which shares are issued

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12
Q

nominal value vs. issue price

A

a company wishes to issue more equity shares, but the potential issue price (IP) os each share may be more than the nominal value (NV)
- difference between IP and NV is Share Premium

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13
Q

Define Share premium

A
  • difference between IP and NV
  • is a Capital Reserve (cannot be distributed)
  • part of the equity account
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14
Q

Nominal Value vs. market value

A

-once a plc starts trading and making profit, value of shares may increase
= Market Value

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15
Q

define equity dividends

A

a distribution of profits - not an expense

  • amount at directors discretion- “dividend or distribution policy”
  • shown as a reduction of the retained earnings in SOCE (statement if changes in equity)
  • not in PandL account
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16
Q

How are equity dividends paid?

A

2 stages:

  1. interim (during the year)
  2. final or proposed (paid after year end)
17
Q

preference dividends

A
  • an expense

- finance cost in PandL account

18
Q

What is the best distribution policy?

A
  • High income = high dividends, less retained earnings

- High Capital Growth= low dividends, more retained earnings

19
Q

What are Reserves?

A

-reserves in the company account are the retained profits and other retained gains of the company added to share capital to show total equity

20
Q

Define revenue reserves

A

(retained earnings) has been built up from profits accumulated as a result of the trading operations of the business reflected in the statement of profit or loss.

distributable as dividend
usually retained profits

21
Q

define capital reserves

A

(equity share capital, share premium, revaluation reserve) represents share capital (nominal value plus any premium) paid into the company by shareholders, plus any unrealised gains recorded as a result of revaluing assets.

  • un-distributable gains
    e. g. share premium and revaluation reserve.
22
Q

define revaluation reserve

A

created to record an increase in the valuation of a non-current asset (usually property).

  • If several years have elapsed since the purchase of the property (or its last revaluation), the value as recorded in the statement of financial position may be unrealistically low, and distort the overall net asset values shown, and a company may choose to revalue certain classes of non-current assets to their fair value (a sort of market value).
23
Q

define Redeemable preference share

A
  • ones that the company will buy back from the shareholder at a fixed date in the future (i.e. they will be redeemed).
  • This means the company has an obligation for a future outflow of resources
  • accouted as debt in SOFP
24
Q

define Irredeemable preference

A
  • is perpetual capital – there is no redemption date

– and so the share capital is accounted for as equity on the statement of financial position and the statement of changes in equity.

  • The accounting treatment of the dividends is the same as for equity dividends –
  • dividends paid in an accounting period are shown as a reduction in retained earnings on the statement of changes in equity.
25
Q

What is a Sole Trader

A

– Individual(s) are sole owners of business – total control
– small businesses – trades and professions
– Easy to set up
– Not a separate legal entity from owners
– Produce accounts for HMRC and lenders
– Unlimited liability – therefore increased risk
– Profits subject to income tax (DI/DII)

26
Q

What is a Partnership?

A

– At least 2 partners who own business – shared control
– Usually quite small, typical in professional services
– Easy to set up – usually a partnership agreement
– Not a separate legal entity
– Generally partners have unlimited liability – therefore increased risk

27
Q

Advantages and Disadvantages of a partnerhsip

A

Advantages:

  • Shared burden of ownership,
  • greater ability to raise capital,
  • opportunity to specialise.

Disadvantages:

  • Can be problematic when one partner wants to leave or another joins – dissolution of partnership may be required.
  • Disagreement between partners is common.
28
Q

advantages and disadvantages of sole trader

A

Advantages

  • ease of set up,
  • limited paperwork and bureaucracy;
  • individual has total control over business.

Disadvantages

  • limited pool of capital and expertise,
  • one individual carries sole responsibility for the business.
  • Not easy to raise capital; often have to use personal assets (e.g. home) as security for borrowing. - risky
29
Q

What is a Limited Company

A

– Few or multiple owners (shareholders) – very little control for individual shareholder
– Limited liability – less risk
– Typical separation of owners and managers
– More formal set-up – articles and memorandum of association registered with Companies House.
– Have to produce annual reports, audit, AGM etc.
– Pay corporation tax on profits

30
Q

Advantages and Disadvantages of Limited Company

A

Advantages:

  • Limited liability,
  • easier to attract funding,
  • shared financial responsibility if business does not succeed.
  • Can use expert managers who are separate from owners so can access vast pools of talent.

Disadvantages:

  • Level of bureaucracy from Companies legislation which is a burden
  • more expensive to set up and administer than others,
  • requirement to file financial information which is publicly available

Introduction to Financial Accounting (13 decks)

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