Chapter 19 • Limited liability companies

• Shares
• Reserves
Introduction to • Bonus and rights issues
company accounting
 Syllabus learning outcomes 1
• Understand the capital structure of a limited liability company including ordinary
shares, preference shares and loan notes.
 Syllabus learning outcomes 2
• Record movements in the share capital and share premium accounts.
• Define a bonus issue and a rights issue, their advantages and disadvantages and show
how they are recorded in the statement of financial position.
 Syllabus learning outcomes 3
• Identify and record the other reserves which may appear in the company statement of
financial position.
 Syllabus learning outcomes 4
• Record dividends in ledger accounts and the financial statements.
• Calculate and record finance costs in ledger accounts and the financial statements.
Overview
Finance costs

Reserves Long term borrowings Income taxes

Introduction to
company accounting

Shares

Accounting treatment

Issue at a premium Bonus issue Rights issue

 Limited liability companies 1
Features
• Limited liability companies offer limited liability to their owners (shareholders).
If the company becomes insolvent, the maximum amount that an owner stands to lose
is his share of the capital of the business.
This is an attractive prospect to investors. Limited liability companies may be private or
public. IAS 1 sets out a suggested format for financial statements.
 Limited liability companies 2
• Owners = shareholders or members
• Large number of owners
• Owner/manager split
• Owners appoint directors to run business on their behalf
• Owners receive share of profits in form of dividends
 Limited liability companies 3
Disadvantages
• Compliance with national legislation
• Compliance with national accounting standards and/or IFRS
• Any formation or annual registration costs
 Limited liability companies 4
Funding
Companies are funded in the following ways:
• Retained profits
• Share capital
• Short term liabilities (trade accounts payable etc)
• Loan notes
Specimen paper question

Source: ACCA Paper FFA/F3 Financial Accounting Specimen Exam

Specimen paper answer

Source: ACCA Paper FFA/F3 Financial Accounting Specimen Exam

 Shares 1
Shares
• The proprietors' capital in a limited liability company consists of share capital.
When a company is set up for the first time it issues shares, which are paid for by
investors, who then become shareholders of the company.
• Shares are denominated in units of 25 cents, 50 cents, $1 or whatever seems
appropriate.
This is referred to as their nominal value.
 Shares 2
Ordinary shares have the following characteristics:
• No right to fixed dividend
• Entitled to remaining profits after preferred dividend
• Entitled to surplus on repayment of capital
 Shares 3
Preferred shares are characterised as follows:
• Rights depend on articles
• Right to fixed dividend with priority over ordinary shares
• Do not usually carry voting rights
• Generally priority for capital in winding up
• May be redeemable (loan) or irredeemable (equity)
 Shares 4
Share capital
• Authorised. The maximum amount of share capital that a company is empowered to
issue.
• Issued. The amount of share capital that has been issued to shareholders. The amount
of issued capital cannot exceed the amount of authorised capital.
 Shares 5
• Called up. When shares are issued or allotted, a company does not always expect to be
paid the full amount of the issue price at once. It might instead call up only a part of
the issue price, and call up the remainder later.
• Paid-up. Called up capital that has been paid.
 Shares 6
• Market value. This is the price at which someone is prepared to purchase the share
value from an existing shareholder. It is different from nominal value.
 Shares 7
The following are the main types of share issue:
• New issue at par or at a premium
• Bonus/scrip/capitalisation issue
• Rights issue
 Shares 8
Loan notes
Companies may issue loan notes. These are long term liabilities not capital. They differ
from shares as follows:
• Shareholder = owner; note holder = payable
• Loan note interest must be paid; not so dividends
• Loan notes often secured on company assets
 Reserves 1
Reserves
Revenue reserves consist of distributable profits and can be paid out as dividends.
• Retained earnings
• Others, as the directors decide, eg general reserve
 Reserves 2
• Share premium. Whenever shares are issued for consideration in excess of their
nominal value, such a premium shall be credited to a share premium account.
 Tackling the exam
Exam focus point:

The share premium account cannot be distributed as a dividend under any

circumstances.
 Reserves 3
Share premium account can be used to:
• Issue bonus shares
• Write off formation expenses and premium on the redemption of shares and loan
notes
• Write off the expenses on a new issue of shares/loan notes and the discount on the
issue of loan notes
 Reserves 4
• Revaluation surplus. Created when a company revalues one or more of its non-current
assets.
• Statutory reserves. The law requires the company to set up these.
 Bonus and rights issues 1
Bonus issue
• A bonus (or capitalisation) issue uses reserves to pay for the issue of share capital.
 Bonus and rights issues 2
Example
• Issue of 5,000 new $1 shares
DEBIT Reserves (share premium or
retained earnings) $5,000
CREDIT Share capital $5,000
 Bonus and rights issues 3
Rights issue
• A rights issue enables existing shareholders to acquire further shares.
 Bonus and rights issues 4
Example
• Issue of 5,000 new $1 shares at $1.50 per share
DEBIT Cash $7,500
CREDIT Share capital $5,000
CREDIT Share premium $2,500
 Lecture example 1
On 1 June 20X6 Rab Co issued a further 200,000 ordinary shares of 50c each for 80c per
share.

Required
Show how this issue of shares would be accounted for and what the statement of
financial position would look like immediately after the issue.
Answer to lecture example 1
Rab Co
$ $
Dr Cash (200,000 × 80c) 160,000
Cr Share capital (200,000 × 50c) 100,000
Cr Share premium account (200,000 × 30c) 60,000

Statement of financial position (extract) as at 1 June 20X0

Equity $
Share capital – 50c ordinary shares (50,000 + 100,000) 150,000
Share premium account 60,000
210,000
 Lecture example 2
RAB CO
STATEMENT OF FINANCIAL POSITION (extract)
$
Share capital – 50c ordinary shares 150,000
Share premium account 60,000
Retained earnings 200,000
410,000
Several years later Rab Co is to make a bonus issue on a 1 for 4 basis.
 Lecture example 2 (cont'd)
Required
Show how this issue of shares would be accounted for and prepare the statement of
financial position of Rab Co immediately after the issue.
Answer to lecture example 2
Bonus Issue
New share capital: 300,000 ($150,000/ 0.5) / 4
×50c = 37,500
Double entry: $ $
Dr Share premium account 37,500
Cr Share capital 37,500

Statement of financial position

$
Share capital – 50c ordinary shares (150,000 + 37,500) 187,500
Share premium account (60,000 – 37,500) 22,500
Retained earnings 200,000
410,000
 Lecture example 3
One year later, Rab Co is to make a rights issue on a 1 for 5 basis. The rights price is $1.50. All shareholders
take up their rights.
The following statement of financial position extract shows the position before the issue:

RAB CO
STATEMENT OF FINANCIAL POSITION (extract)
$
Share capital – 50c ordinary shares 187,500
Share premium account 22,500
Retained earnings 230,000
440,000
 Lecture example 3 (cont'd)
Required
Show how this issue of shares would be accounted for and prepare the statement of
financial position of Rab Co immediately following the issue.
Answer to lecture example 3

Rights Issue $ $
New share capital: 375,000 / 5 × 50c 37,500
Share premium: 375,000 / 5 × $1 75,000

$ $
Dr Cash 112,500
Cr Share capital 37,500
Cr Share premium account 75,000
Answer to lecture example 3 (cont'd)

RAB CO
STATEMENT OF FINANCIAL POSITION (extract)

$
Share capital – 50c ordinary shares 225,000
Share premium account 97,500
Retained earnings 230,000
552,500
 Lecture example 4
ABC Co has the following share capital:
100,000 6% $1 preference shares
200,000 50c ordinary shares

Retained earnings at the beginning of the year were $125,000.

During the year ended 31 December 20X7 it made the following profit:
$
Profit before tax 60,000
Income tax expense 10,000
Profit for the period 50,000
 Lecture example 4 (cont'd)
Dividends paid and declared during the year were as follows:
Interim dividend paid 5c per share
Final dividend declared on 20 January 20X8 10c per share

Required
Show the movement in retained earnings for ABC Co for the year ended 31 December 20X7.
Answer to lecture example 4
ABC Co
Reconciliation of movement in retained earnings
for year ended 31 December 20X7

$ $
Retained earnings at beginning of year 125,000
Profit for the period 50,000
Dividends – preference 6,000
– ordinary (200,000 shares × 5c) 10,000
(16,000)
Retained earnings at end of year 159,000

Note. Dividends which have been paid are deducted from retained earnings
in the statement of financial position. Proposed dividends are not adjusted
for.
 Lecture example 5
Lauren Ltd has a year end of December.
When preparing its financial statements for the year ended 31 December 20X5, Lauren
Ltd estimated that its income tax payable would be $62,000.
Lauren Ltd settled this tax liability on 30 September 20X6, paying $65,000. The tax
estimate for the year ended
31 December 20X6 is $43,000.
 Lecture example 5 (cont'd)
Required
(1) Record the tax entries for the years ended
31 December 20X5 and 20X6 in the ledger accounts.
(2) Prepare the tax note which relates to the statement of
profit or loss for the year ended 31 December 20X6.
Answer to lecture example 5

(1)
Income tax expense (SPL)
$ $
31.12.X5 Current tax payable 62,000 31.12.X5 Statement of profit 62,000
30.9.X6 Current tax payable 3,000 or loss
31.12.X6 Current tax payable 43,000
Answer to lecture example 5 (cont'd)

Current tax payable (SOFP)

$ $
31.12.X5 Balance c/d 62,000 31.12.X5 Income tax expense 62,000
62,000 62,000
30.9.X6 Bank 65,000 1.1.X6 Balance b/d 62,000
30.9.X6 Income tax expense 3,000
31.12.X6 Bal c/d 43,000 31.12.X6 Income tax expense 43,000
108,000 108,000
1.1.X7 Balance b/d 43,000
Answer to lecture example 5 (cont'd)
(2) Tax note for the year ended 31 December 20X6
$
Tax charge for the year 43,000
Under provision in respect of prior periods 3,000
46,000
Chapter summary 1
1 Introduction
 Companies use the same method of bookkeeping to record
transactions. There are however some differences in the
terminology and the formats used.
Chapter summary 2
2 Proforma financial statements
 The format in which companies must produce their financial
statements is prescribed by the accounting standard IAS 1.
Chapter summary 3
3 Share capital
 An entity may issue two main types of shares. Ordinary or
equity shareholders have voting rights and therefore have
control over the company. Preference shareholders are really
just providers of finance to the business and have limited
rights.
Chapter summary 4
4 Share capital: accounting treatment
 In a limited liability company the shareholders own the
business. A company may raise finance by issuing new share
capital. Where shares are issued at a premium to their
nominal value, the premium is recorded in the share premium
account. A bonus issue is where the company issues shares for
no cash consideration. With a rights issue, shares are issued
for cash but the price charged is slightly lower than the
current market price.
Chapter summary 5
5 Reserves
 A company may have several different types of reserve such as
a share premium account, a revaluation surplus and retained
earnings.
Chapter summary 6
6 Dividends
 Shareholders may receive a dividend as a return on their
investment; these are accounted for as a deduction to
retained earnings.
Chapter summary 7
7 Long term borrowings
 A company may also raise finance by issuing debt such as loan
notes or debentures.
Chapter summary 8
8 Finance costs
 It will have to pay interest on any debt that it issues and this
will be shown as 'finance costs' in the statement of profit or
loss.
Chapter summary 9
9 Current tax
 Companies pay corporation tax on their profits.
Chapter summary 10
10 Comparison
 Sole traders and partnerships are very similar in their nature
whilst companies are quite different. You must ensure that
you are happy with both the differences and similarities.