Sample Notes: Limited Companies

O Level Accounting — Detailed Notes
Chapter 5.3: Limited Companies

🔹 A. Introduction to Limited Companies

1. Definition

• A limited company is a business entity registered under company law that is legally separate from its owners.
• It is owned by shareholders and managed by directors.

2. Types of Limited Companies

• Private Limited Company (Ltd):
  • Shares not traded publicly.
  • Owned by a small group (often family or close investors).
• Public Limited Company (PLC):
  • Shares can be traded on stock exchanges.
  • Requires stricter regulations and public disclosure.

🔹 B. Limited Liability

1. Meaning

• Shareholders are not personally liable for company debts beyond the amount they have invested.
• If the company fails, shareholders lose only what they paid or agreed to pay for their shares.

2. Example

• If a shareholder buys 100 shares at Rs. 10 each (Rs. 1000 investment) and the company goes bankrupt:
  • Maximum loss = Rs. 1000.
  • Personal assets of the shareholder are not at risk.

🔹 C. Advantages of Operating as a Limited Company

• Limited Liability protects personal wealth.
• Can raise large capital by issuing shares (especially PLCs).
• Ownership can be easily transferred through sale of shares.
• Continuity of existence: Company continues even if shareholders die or leave.
• Credibility improves with suppliers, banks, and customers due to legal structure.
• Professional management through board of directors.

🔹 D. Disadvantages of Operating as a Limited Company

• More complex and expensive to set up compared to sole traders or partnerships.
• Must comply with legal regulations and audits.
• Required to publish accounts (especially PLCs).
• Decision-making may become slow due to multiple levels of authority.
• Dilution of control if many shareholders exist.

🔹 E. Meaning of Equity

1. Definition

• Equity represents the owners’ interest in the company.
• It is the residual value after all liabilities have been settled.
• Also known as shareholders’ equity or net assets.

2. Formula

• Equity = Total Assets – Total Liabilities

3. Components

• Ordinary Share Capital
• Retained Earnings
• General Reserve
• Any other reserves (e.g., revaluation reserve, not examined at O Level)

🔹 F. Capital Structure of a Limited Company

1. Preference Share Capital

• Shareholders receive fixed dividends before ordinary shareholders.
• Less risky for investors than ordinary shares.
• May be redeemable (company buys back in future) or non-redeemable (permanent capital).

2. Ordinary Share Capital

• Represents main ownership of the company.
• Dividends are not fixed — depend on profits.
• Shareholders have voting rights and control.

3. General Reserve

• Part of retained profits set aside for future use or emergencies.
• Not distributed as dividends immediately.

4. Retained Earnings

• Profits kept in the business after paying dividends.
• Used for expansion, debt repayment, etc.

🔹 G. Share Capital Terminology

1. Issued Share Capital

• Total number of shares issued to shareholders.
• Reflects the amount that shareholders have agreed to pay (fully or partially).

2. Called-up Share Capital

• The portion of issued capital that the company has requested payment for.
• Not always 100% of issued shares.

3. Paid-up Share Capital

• Actual amount received by the company from shareholders.
• Paid-up ≤ Called-up ≤ Issued

4. Example

• Company issues 10,000 shares at Rs. 10 = Rs. 100,000 (Issued Capital)
• Calls up Rs. 8 per share = Rs. 80,000 (Called-up Capital)
• Receives Rs. 70,000 due to unpaid calls = Rs. 70,000 (Paid-up Capital)

🔹 H. Share Capital vs Loan Capital

🔹 I. Redeemable vs Non-redeemable Preference Shares

1. Redeemable

• Can be bought back by the company at a future date.
• Seen as temporary capital.

2. Non-redeemable

• Remain permanently in the business unless sold by the investor.
• Treated as long-term equity.

🔹 J. Key Financial Statements for Limited Companies

1. Income Statement (Profit and Loss Account)

• Shows:
  • Revenue
  • Cost of Sales
  • Gross Profit
  • Operating Expenses
  • Operating Profit
  • Interest and Tax
  • Net Profit (Profit for the year)
• Used to determine profitability of the company.

2. Statement of Changes in Equity

• Shows movement in equity accounts:
  • Opening balances
  • Add: Profit for the year
  • Less: Dividends
  • Add: Transfers to reserves
  • Closing balances of each component (share capital, reserves, retained earnings)

3. Statement of Financial Position (Balance Sheet)

• Shows company’s financial position at a specific date:
  • Non-current assets (e.g., buildings, machinery)
  • Current assets (e.g., cash, inventory, trade receivables)
  • Equity (as explained above)
  • Liabilities (both current and long-term)

🔹 K. Adjustments to Financial Statements (Same as 5.1 Sole Traders)

• Accruals: Expenses incurred but not yet paid → Add to expenses and show as current liability.
• Prepayments: Expenses paid in advance → Deduct from expense and show as current asset.
• Depreciation: Reduce value of fixed assets over time.
• Provision for Doubtful Debts: Estimate of debts not expected to be collected → Reduce receivables and add to expenses.

🔹 L. Worked Example — Statement of Financial Position (Simple Format)

XYZ Ltd. — Statement of Financial Position as at 31 December 20XX

Assets

• Non-current Assets: Rs. 80,000
• Current Assets: Rs. 30,000
  Total Assets: Rs. 110,000

Equity and Liabilities

• Ordinary Share Capital: Rs. 50,000
• Preference Share Capital: Rs. 20,000
• Retained Earnings: Rs. 15,000
• General Reserve: Rs. 5,000
• Total Equity: Rs. 90,000
• Non-current Liabilities (Debentures): Rs. 10,000
• Current Liabilities (Trade Payables): Rs. 10,000
  Total Equity and Liabilities: Rs. 110,000

🔹 M. Keywords to Remember

• Limited Liability
• Equity
• Ordinary / Preference Shares
• Retained Earnings
• General Reserve
• Debentures
• Issued / Called-up / Paid-up Capital
• Redeemable / Non-redeemable Shares
• Income Statement
• Statement of Changes in Equity
• Statement of Financial Position