2 Distinctions of companies Separate legal entity Separation of ownership and management Ownership through shares Limited liability is usual. It is the liability of the shareholders that is limited. It is limited to the amount paid for their shares. Profits are distributed as “dividends”.

3 Requirements Legislative requirements for companies contained in: Companies Act 1993 Financial Reporting Act 1993 Financial Reporting Amendment Act 2006 Constitution – document established by the company to govern its operations. Companies are not required to have their own constitution. If they do not they are governed by the provisions of the Companies Act 1993.

4 Equity The capital in a company is called ‘equity’ Equity is made up of: Paid-in capital/issued capital – ordinary or preference shares Retained Earnings – built up from retained profits Reserves – such as revaluation surplus, foreign currency translation or general reserves

5 Classes of Shares Ordinary shares Provide a claim against the entity that ranks behind the claims of creditors and some preference shareholders Confers voting rights on shareholders Entitles their owners to distribution of profits in the form of dividends – however there is no guarantee of a dividend payout Dividends not paid in one year do not accrue

6 Preference Shares Subject to preferential treatment, often with receipt of dividends or order of ranking for asset distributions Voting rights vary - some have voting rights, others don’t and some have voting rights only if dividends remain unpaid Shares can be participating, convertible or redeemable

7 Types of Preference Shares Participating – may, after receiving a preference dividend at a fixed rate, participate with ordinary shareholders in further profits distributed Convertible – right of conversion to ordinary shares Redeemable – ability to redeem shares for cash at a later date Note that some have the characteristics of equity and others the characteristics of debt

8 Dividends The most common form of distribution to shareholders is in the form of dividends Dividends are authorised by the directors and can be paid at any time in the year Interim dividends are paid in anticipation of the current year’s profit Final dividends are authorised and paid after balance date once the financial statements have been completed

9 Dividend Issue DateDrCr Payment Date Dividends paidXX CashXX Record distribution of dividends Balance Date EquityXX Dividends paidXX Record dividends paid closed to equity

10 Solvency test In order to make a distribution (such as pay a dividend) a company must satisfy the solvency test. The solvency test is defined in s 4 Companies Act Two limbs – liquidity (or cash flow test) and balance sheet test Both parts of the solvency test must be satisfied immediately after a distribution is made.

11 The tests… 1. Liquidity The company is able to pay its debts as they become due in the normal course of business. Look at the cash forecasts – these are essential in establishing future cash availability. 2. Balance Sheet The value of the company’s assets is greater than the value of the liabilities – including contingent liabilities. The directors must have regard to the most recent financial statements.