Limited Companies (Copy)
5.3 Limited Companies
Definition and Structure
- A limited company is a business owned by shareholders and run by directors.
- It is a separate legal entity from its owners.
- Owners have limited liability, meaning they are only responsible for the company’s debts up to the value of their investment.
- There are two types:
- Private limited company (Ltd) – shares are not publicly traded
- Public limited company (PLC) – shares are traded on the stock exchange
Advantages of Operating as a Limited Company
- Limited liability protects shareholders’ personal assets
- Separate legal identity allows the company to own property and enter into contracts
- Easier to raise large amounts of capital through sale of shares
- Ownership can be transferred via sale of shares without affecting continuity
- Greater credibility and status in the business environment
- Possibility of specialisation through directors and management
Disadvantages of Operating as a Limited Company
- More legal requirements and administrative burdens
- Must publish financial statements publicly (especially PLCs)
- Profits may be subject to double taxation (company tax and dividends tax)
- Less control for owners compared to sole traders or partnerships
- Decision-making can be slower due to required board approvals
Limited Liability
- Limited liability means that shareholders’ financial risk is limited to the value of their investment.
- Personal assets cannot be used to cover company debts.
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Meaning of Equity
- Equity in accounting refers to the shareholders’ stake in the business.
- Equity is made up of:
- Share capital (preference and ordinary)
- General reserve
- Retained earnings
Formula:
Equity = Share Capital + General Reserve + Retained Earnings
Capital Structure of a Limited Company
- A limited company can raise finance through share capital and loan capital
- Share Capital includes:
- Ordinary shares (equity shares): entitle holders to dividends and voting rights
- Preference shares: fixed dividends, usually no voting rights
- Loan Capital includes:
- Debentures: long-term loans with fixed interest
Issued, Called-up, and Paid-up Share Capital
- Issued Share Capital: The nominal value of shares that have been offered to shareholders
- Called-up Share Capital: The part of issued capital that shareholders have been asked to pay
- Paid-up Share Capital: The amount shareholders have actually paid
Example:
If 10,000 shares of $1 are issued:
- Issued Capital = $10,000
- Called-up = $8,000
- Paid-up = $6,000
Share Capital vs Loan Capital
| Feature | Share Capital | Loan Capital (Debentures) |
|---|---|---|
| Ownership | Yes | No |
| Voting Rights | Ordinary shares only | None |
| Dividend/Interest | Dividends (not guaranteed) | Fixed interest |
| Repayment | No obligation | Must be repaid at maturity |
| Risk to investor | High | Low (secured) |
| Appears in | Equity section | Non-current liabilities |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Types of Preference Shares
- Redeemable Preference Shares: Repayable by the company at a future date
- Non-redeemable Preference Shares: Cannot be bought back by the company
Income Statement of a Limited Company
- Structure similar to sole trader income statement:
- Revenue
- Cost of Sales
- Gross Profit
- Operating Expenses
- Operating Profit
- Interest on debentures
- Profit before tax
- Tax expense
- Profit after tax (Net profit)
Statement of Changes in Equity
| Particulars | Ordinary Share Capital | General Reserve | Retained Earnings | Total Equity |
|---|---|---|---|---|
| Opening Balance | 100,000 | 20,000 | 50,000 | 170,000 |
| Profit for the Year | 30,000 | 30,000 | ||
| Transfer to General Reserve | 5,000 | (5,000) | – | |
| Dividends Paid | (10,000) | (10,000) | ||
| Closing Balance | 100,000 | 25,000 | 65,000 | 190,000 |
Statement of Financial Position (Balance Sheet)
| Section | Items Included |
|---|---|
| Non-current assets | Property, plant, and equipment, intangible assets |
| Current assets | Inventory, trade receivables, bank, cash |
| Total Assets | Non-current + Current assets |
| Equity | Ordinary Share Capital, Preference Share Capital, Retained Earnings, Reserves |
| Non-current liabilities | Debentures, long-term loans |
| Current liabilities | Trade payables, bank overdraft, short-term loans, accruals, dividends payable |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Adjustments in Financial Statements
Adjustments made for limited companies are similar to sole traders:
- Depreciation using:
- Straight-line method
- Reducing balance method
- Revaluation method
- Accruals and prepayments for expenses and incomes
- Irrecoverable debts and provision for doubtful debts
- Drawings/Owner’s use is not applicable in limited companies — dividends replace drawings
Worked Example: Income Statement Extract with Adjustments
Additional Info:
- Rent paid includes $2,000 prepaid
- Depreciation: 10% reducing balance on equipment ($40,000)
- Debenture interest unpaid = $1,000
Adjustments:
- Rent expense = Rent paid – Prepaid = e.g. $12,000 – $2,000 = $10,000
- Depreciation = 10% of $40,000 = $4,000
- Interest payable = add $1,000 to interest expense, include as current liability
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course