1. Financial Statements of Limited companies ACCN 2 – Financial and Management Accounting Mr. BarryA-level Accounting Year 12

2. Limited Liability companies In this topic you will learn: Key terms and features of limited company accounts How to prepare the profit and loss account inc appropriation account. How to prepare a balance sheet of a limited company that takes into account current liabilities such as corporation tax, final proposed dividends, debenture interest due, non current liabilities and details of shares and reserves. Mr. BarryA-level Accounting Year 12

3. Introduction – Limited liability The main disadvantages of being a sole trader are: That liability is not limited to the amount of money invested by the owner. This means that if the business fails and creditors cannot be paid from the proceeds raised from the sale of business assets then the proprietor must provide further finance from his or her private assets. This could mean that the business failure could result in a Sole Trader losing both his or her business assets and some, if not all, of his or her personal assets; That generally the amount of money that one person can afford to invest in a business is comparatively small. Mr. BarryA-level Accounting Year 12

4. Types of limited liability company There are 2 types of limited company: Private Limited Companies – There are far more LTD Co’s than PLCs – LTD cannot offer shares to the general public – They can’t be listed on the stock exchange – They are often run by a family or group of friends and the business name must end with the letters LTD Mr. BarryA-level Accounting Year 12

5. Types of limited liability company PUBLIC LIMITED COMPANY Public limited Companies share capital must be more than £50,000 They must produce more detailed accounts than LTDs They can raise capital from the general public They generally find it easier to raise capital than LTDs – since members are likely to view them as less risky than LTDs – this might also result in a lower rate of interest being charged by lenders of finance Companies that issue their shares through the stock exchange are referred to as quoted or listed Companies. The name of a PLC must end with PLC !! Mr. BarryA-level Accounting Year 12

6. Limited liability status ADVANTAGES OF LIMITED LIABILITY STATUS Limited liability status for shareholders Larger amounts of capital can be raised by directors for use within the company DISADVANTAGES OF LIMITED LIABILITY STATUS Annual accounts must be audited Directors must complete an annual return and file their accounts with the Registrar of Companies The filed accounts may be inspected by the public Copies of the Companies annual audited accounts must be sent to each shareholder and debenture holder All these disadvantages involve extra expenditure Mr. BarryA-level Accounting Year 12

7. Types of shares When a limited company is incorporated it raises capital so that it can purchase the fixed assets necessary to enable it to conduct its business. It raises capital through the issue of shares. In the balance sheet this total is called the SHARE CAPITAL. There are 2 main types of shares issued by a limited company: PREFERENCE SHARES Preference shareholders receive a fixed dividend which is expressed as a % of the nominal value of the share. E.g. 7% preference share of £1 each; 8% preference shares of 50p each. This dividend can only be paid if the company earns sufficient profits, but preference shareholders DO receive their dividend before the ordinary shareholders receive theirs. In the event of a company going into liquidation the preference shareholders are entitled to receive the nominal value of their shares before the ordinary shareholders are repaid. Mr. BarryA-level Accounting Year 12

8. Types of shares Nominal Value is the face value or par value of a share, for example the nominal value of ordinary shares in Matalan plc is 10p while the nominal value of ordinary shares in Whitbread plc is 50p Shares are the equal parts into which a company’s capital is divided ORDINARY SHARES (equity shares) These are the most common type of share. The ordinary shareholders are the owners of the business and as such have voting rights. This means that the have control of the company. They appoint and dismiss directors. They also decide whether the dividend proposed by the directors is appropriate All the profits remaining after preference share dividend belong to the ordinary shareholders – although only the part of the profits not retained to expand or replace fixed assets will be paid to them as dividend. Mr. BarryA-level Accounting Year 12

9. Types of Share Capital A. Preference Shares Preference shareholders are entitled to fixed % of dividends before any ordinary dividends are paid. No voting rights. I) Cumulative preference shares Any unpaid dividends on cumulative preference shares can be carried forward to a later year. II) Non-cumulative preference shares the unpaid dividends cannot be carried forward to later years. B. Ordinary Shares - The dividends of ordinary shares are not fixed. They depend on the return of the company. - Ordinary shareholders are paid only after all other claims have been met. - Ordinary shareholders usually have voting rights. Mr. BarryA-level Accounting Year 12

10. Example: Cumulative preference shares Year 1 Year 2Year 3 £ £ £ Net Profit / (Loss) for the year before appropriations(1,000) (2,000) 50,000 5,000 10% Cumulative Preference Shares of £1 each Dividend Nil Nil 1,500 Mr. BarryA-level Accounting Year 12

11. Example: Non-cumulative preference shares Year 1 Year 2Year 3 £ £ £ Net Profit / (Loss) for the year before appropriations(1,000) (2,000)50,000 5,000 10% Cumulative Preference Shares of £1 each Dividend Nil Nil 500 Mr. BarryA-level Accounting Year 12

12. Mr. BarryA-level Accounting Year 12

13. Types of shares You will encounter a number of headings that relate to a company’s share capital. Authorised share capital (also known as ‘registered share capital’ or nominal share capital’) sets the maximum number of each type of share that a company can issue to its shareholders. It is stated in the company’s memorandum and articles of association. Issued share capital – shows the actual number of each type of share that the company has issued to its shareholders. It cannot exceed the authorised share capital. Mr. BarryA-level Accounting Year 12

14. Worked example Spud McMurphy Ltd Balance Sheet as at 30 Nov 2005 £ £ FIXED ASSETS Premises at cost400,000 Machinery at cost120,000 Vehicles at cost 80,000 600,000 CURERET ASSETS Stock 30,000 Bank 70,000100,000 700,000 Authorised share capital 750,000 Ordinary shares of £1 each750,000 1,000,000 6% preference shares of 50p each500,000 Issued Share Capital 500,000 Ordinary shares of £1 each500,000 400,000 6% Preference shares of 50p each200,000 700,000 Mr. BarryA-level Accounting Year 12

15. Activity QUESTION The following info is given for Arbes Ltd as at 30 April 2011: Authorised share capital 500,000 ordinary shares of 50p each, issued share capital 300,000 ordinary shares 50p paid; machinery at costs £80,000; vehicle at cost £40,000; stock £25,000; trade debtors (receivables) £15,000; bank balance £1,000, trade creditors (payables) £11,000 REQUIRED: Prepare a Balance sheet as at 30 April 2011 Mr. BarryA-level Accounting Year 12

16. Debentures / Loans Debentures Many limited companies raise additional capital by issuing debentures. These are long term loans to the company. A debenture is the legal document issued by the company that is managing the debt. Debentures are generally secured against the company’s assets. The security may be fixed, that is it related to a specific asset or group of assets, or it may be a floating charge where no specific assets are identified. If the company were to be closed / wound up, the debenture shareholders would be in a safer position than preference shareholders or the ordinary shareholders because of this security. Debentures are usually for a fixed time period and are redeemable by the company at the end of that period. Like all forms of borrowing, the debt has to be serviced and the interest due will usually be paid half yearly. The interest that the company pays to the holders of the debentures, like all interest payable, is a charge against profits and appears as an expense on the P & l account. Mr. BarryA-level Accounting Year 12

17. Debentures / Loans NOTE Debenture interest is NOT an appropriation of profits. It must be paid whether the company are profitable or not. An issue of debentures will have the following effect on the balance sheet: Increase bank balance Increase creditors: amounts due in more than 1 yr OR Decrease bank overdraft Increase creditors: amounts falling due in more than 1 year Debentures are NOT part of share capital. Debenture holders are NOT shareholders (equity). We show debenture holders under the title ‘Creditors: amounts falling in more than 1 year. The amount is deducted from the total assets less current liabilities. Mr. BarryA-level Accounting Year 12

18. Debentures / Loans Here is an example of a balance sheet including debentures. ToddCo Plc Summarised Balance Sheet as at 30 th Sept 2006 £ Fixed assets at Cost750,000 Current Assets150,000 Creditors: falling due within 1 year 60,000 90,000 Total assets less Current Liabilities840,000 Creditors: falling due in more than 1 year 7% debentures (2035)200,000 640,000 Share Capital and reserves640,000 Debentures should be shown in the BS with all their details e.g. 7% debentures (2035), means the interest to be paid to the lenders is 7% per year. The 2035 stands for the date the Co will redeem the debentures. Mr. BarryA-level Accounting Year 12

19. Revaluation Reserves Many Limited Companies revalue some of their assets to reflect an increase in the value of those assets and to ensure that the balance sheet reflects the permanent change in the value of the assets and therefore the capital structure of the business (remember the accounting equation?) Generally, the only assets to be re-valued upwards are land and buildings. Why do companies revalue their assets while sole traders do not? If the Co’s assets do not reflect a current market value the company could be subject to a hostile takeover bid by a bigger rival company. The increase in the value of the FA’s is matched with an increase in reserves. The revaluation reserve is capital reserve and is not therefore available for dividend purposes. This reserve is a profit due to inflation that will not be realised as cash until the asset is sold. Mr. BarryA-level Accounting Year 12

20. Revaluation Reserves The creation of a revaluation reserve clearly illustrates the earlier point about reserves not being cash put aside for the use in the future/ All that has happened is that the top part of the balance sheet has been increased by the fixed asset being revalued and the bottom part has been increased by the fixed asset being revalued and the bottom part has been increased by the same amount. I purchased a flat for £150,000 and I am confident that I will sell it for 200,000. the increase in value can’t be used to buy a new car or luxury holiday. It is not cash – it is unrealised profit. Mr. BarryA-level Accounting Year 12

21. Revaluation Reserves Reserves are NOT piles of cash waiting to be spent ! In the following examples some Co’s are limited co’s and others are PLC’s. Treat both in the same way. Also look at the ‘par value’ of the shares. The values range from 1p to £1. the par value can be any amount; it will affect your workings for the question. It may affect the ability of the company to raise future finance. Mr. BarryA-level Accounting Year 12

22. Revaluation Reserves WORKED EXAMPLE The summarised balance sheet of Pox plc as at 30 th June 2011 shows: £ £ Fixed Assets at cost400,000 LESS Aggregate Depreciation 50,000 350,000 Current Assets 99,000 Bank Balance 1,000 100,000 Creditors falling due in LESS than 1 year 40,000 60,000 410,000 Share Capital and Reserves Ordinary shares of 25p each400,000 Profit and Loss account 10,000 410,000 The fixed assets are revalued at £600,000 on 1 st July 2011 REQUIRED: Prepare the balance sheet of Pox plc as at 1 July 2011 after the assets have been re-valued. Mr. BarryA-level Accounting Year 12

23. Revaluation Reserves ANSWER The summarised Balance sheet of Pox Ltd as at 1st July 2011 is shown: £ £ Fixed Assets at cost600,000 Current Assets 99,000 Bank Balance 1,000 100,000 Creditors falling due in LESS than 1 year40,000 60,000 660,000 Share Capital and Reserves Ordinary shares of 25p each400,000 Revaluation account250,000 Profit and Loss account 10,000 660,000 Mr. BarryA-level Accounting Year 12

24. Revaluation Reserves - question Question x The summarised Balance Sheet of Orm Ltd as at 31 October 2010 is shown: £ Fixed Assets at cost250,000 Current Assets 40,000 Bank Balance 8,000 48,000 Creditors falling due in LESS than 1 year 36,000 12,000 262,000 Share Capital and Reserves Ordinary shares of 10p each200,000 Profit and Loss account 62,000 262,000 The fixed assets are revalued at £400,000 on 1 st November 2010 Prepare the balance sheet as at 1 st November 2010, after the assets have been revalued. Mr. BarryA-level Accounting Year 12

25. Share premium Once a company is established the value of its ordinary shares will vary (on the stock market). For example, if the original par / nominal value of share was £1 its value will increase as the company builds up undistributed profits. If the company makes a fresh issue of shares it is permitted (by law) to offer these at a price excess of the nominal (par) value of the shares. The EXTRA is called the ‘share premium’ Mr. BarryA-level Accounting Year 12

26. Share premium The ‘share premium’ is a reserve. On a company’s balance sheet it should be placed under the heading RESERVES and be the first in the list. The share premium is known as a ‘capital reserve’. This technical term implies that the reserve did not arise from normal trading activities. The Companies Act forbid capital reserves to be used to finance cash dividends for shareholders. Mr. BarryA-level Accounting Year 12

27. Share premium Share premium account is credited when a company issues shares at a price that is greater than the nominal value of the shares. For example: A Todd Co Plc sold 5000 ordinary shares of £1 each at a market value of £1.50 and then also sold 2 million shares with a nominal value of 50p for a market price of 80p. Then Todd Co plc would observe the following: £ ££ Ordinary Share Share Premium Finance Capital Account Account Raised 5000 £1 ordinary shares 5,000 2,500 7,500 2million 50p ordinary share 1,000,000 600,00 1,600,000 Mr. BarryA-level Accounting Year 12

28. Share premium Therefore as shares are each given a NOMINAL value, e.g. a value at which they are worth as part of the company ownership. However because the stock market buyers may be willing to pay a higher price than this, the company can increase the selling price above the shares value, therefore known as Nominal Value plus Share Premium. If you sell shares through a stock broker at a higher price than you paid for them this will not give rise to a share premium account. This is a private transaction and is not recorded in the company books of account. Mr. BarryA-level Accounting Year 12

29. Share premium WORKED EXAMPLE Summarised balance Sheet as at 31 st December 2010 of Sweat plc £ £ Fixed Assets at cost400,000 Current Assets 74,000 Bank Balance 6,000 80,000 Creditors falling due in LESS than 1 year 30,000 50,000 450,000 Share Capital and Reserves Ordinary shares of £1 each350,000 Profit and Loss account100,000 450,000 On 31 st January 2011 the company issues a further 200,000 ordinary shares of £1 each at a price of £1.30 each. REQUIRED: Prepare a summarised Balance Sheet as at 31 January 2011 for Sweat plc as it would appear immediately after the share issue. Mr. BarryA-level Accounting Year 12

30. Share premium ANSWER Sweat plc summarised Balance Sheet as at 31 January 2011 £ Fixed Assets at cost400,000 Current Assets 74,000 Bank Balance(6000 + 260,000) 266,000 340,000 Creditors falling due in LESS than 1 year 30,000310,000 710,000 Share Capital and Reserves Ordinary shares of £1 each (350,000 + 200,000)550,000 Share Premium account 60,000 Profit and Loss account100,000 710,000 Mr. BarryA-level Accounting Year 12

31. Interim dividends The directors of a limited company can pay dividends mid year. These dividends are called interim dividends. If this happens preference shareholders will receive half of their fixed dividend and ordinary shareholders will receive a dividend agreed by the directors. At the year end all the dividends, including interim dividends, must be shown in the appropriation account. However, because the interim dividends will already have been paid they will not appear as a current liability on the balance sheet. Mr. BarryA-level Accounting Year 12

32. Interim dividends Activity The directors of a limited company have agreed the payment of an interim dividend of 3p (£0.03) per share to the company’s ordinary shareholders. Currently the company has an issued ordinary share capital of £400,000 consisting of 50p (£0.50) ordinary shares. a)Calculate the total amount of the interim dividend to be paid to ordinary shareholders b)Explain whether or not the interim dividend will appear on the company’s balance sheet prepared at the end of the financial year. Mr. BarryA-level Accounting Year 12

33. A rights issue of Shares This is an issue of shares by a company designed to raise cash Potential problems are as follows: 1.No guarantee that the share issue will prove attractive to investors 2.Share issues are expensive because they can involve the use of specialist financial institutions to manage the issue Mr. BarryA-level Accounting Year 12

34. A rights issue of Shares What items will be affected? 1.Cash and cash equivalents will increase by the total cash raised by the issue 2.Issued shares will increase by the face value of shares 3.Share premium will increase will the additional amount raised by the share issue above the face value of the shares Mr. BarryA-level Accounting Year 12

35. Example 1. The directors of Harriton Ltd. Made a rights issue of ordinary shares at 3 shares for every 5 shares currently held. Their shares were offered at a price of £1.80 each. The rights issue was fully subscribed. Extract from trial balance £ £ Bank 45,000 3m ordinary shares of £1 each 3,000,000 Share premium 600,000 Mr. BarryA-level Accounting Year 12

36. Solution Workings (rights issue) (figures in £000s) Issued shares: 3 for 5 shares offered 3/5 x 3,000 shares = 1,800 shares of £1 each Share premium: 1,800 x 80p premium = £1,440 Cash received: 1,800 x £1.80 = £3,240 How will these affect the figures in the balance sheet? Mr. BarryA-level Accounting Year 12

37. A bonus issue of shares A bonus issue occurs when the directors of a company decide to change the structure of the company’s financial position It increases share capital but there is no cash involved, instead it reduces reserves DEBIT Reserves (share premium, revaluation reserves or retained earnings) CREDIT Share Capital Mr. BarryA-level Accounting Year 12

38. Example 1. CompanyCurrent issued capital Face value of shares Scale of bonus (No. of bonus) Bonus shares issued P plc£12m£11 for 4? Q plc3.6m25p1 for 5? Mr. BarryA-level Accounting Year 12