Companies

IMPORTANT DEFINITIONS

1) Company
A company is a legal entity formed by individuals to operate any business with the
declared goals & objective (for e.g. to maximize profits, maximization of
shareholders wealth etc.)
2) Share
Share is one unit of ownership in a company.

3) Shareholder
The person who is holding the share (the investor)

4) Dividend
A dividend is a distribution of profits by a corporation to its shareholders (i.e. the
share of profit for investor upon his investment in the company).

5) Limited Liability
Shareholder is not personally liable for any losses of the company.

6) Unlimited Liability
Shareholders are personally liable for any company losses.

7) Stewardship Responsibility
The idea that directors are managing the company on behalf of the shareholders
not for their own profit.

8) Directors
The individuals who run the affairs the of the company business. They are
selected by the shareholders and can anyone (from the shareholders or from
outside the business).
9) Listed Company
Company registered at stock exchange (these are public companies)

10) Unlisted/Private Company

Company not registered at stock exchange (mainly these are private limited
companies)

11) Stock Exchange/ Market

Market where buying and selling of shares takes place.

Characteristics of Company
i) Separate legal entity.
ii) Limited liability.
iii) Ownership lies with the shareholders.
iv) Management lies with the directors.
v) Compulsory annual audit (in case of public company).
vi) Publicly available financial statements.
vii) More formalities (legal) in formation.

Advantages of company
1. More profits.
2. Easily transferable shares.
3. Limited liability.
4. Many tax advantages.
5. Separate ownership and management.
Disadvantages of company
1. Costly formation (registration cost, set up cost).
2. Division of profits.
3. More burden on directors (more legislative work).
4. Huge capital requirement.
5. Huge costs to comply with company’s legislation (auditor’s fee).
 6. Comparison

Company VS Sole Tradership

i) Separate legal entity No separate legal entity
ii) Limited liability Unlimited liability
iii) More capital and profits Less capital and profits
iv) More formalities in formation No formalities in formation
v) Separate ownership and Same ownership and
management (share-holders & management ( One man control)
directors)
vi) Co gives dividends to No dividends
shareholders
vii) Capital is expressed in terms of Capital is not expressed in terms
shares of shares
viii) No concept of drawings. Drawings are shown as a
Anything withdrawn for personal deduction from the capital.
use is considered as receivable
from owner
ix) Tax is shown separately as a Tax is a part of operating
deduction from PBT expenses and is not shown
separately.
x) Finance cost is shown separately Finance cost is a part of
as a deduction from PBIT operating expenses and is not
shown separately.

Company Shareholder
Share issuer Investor (Share Receiver)
Borrower of money Lender of money
Capital generated (Equity) Investment generated (Assets)
Pay dividends Receive dividends
Company’s Finance

1) Ordinary shares
2) Preference shares
3) Debentures/Loan notes/Loan stock/Long term loans

Ordinary Shares/Common Stock

Ordinary shares, also known as common shares, is defined as shares of

a company that give shareholder the voting right in the company's meeting and
also the right to receive dividends from the corporation's profits. It is mainly
issued to generate funds.

Types of Ordinary Shares

1) Authorized Share Capital

The maximum number of shares which company can issue (its registered capital)
e.g. 50,000 shares x £1 each = £50,000

2) Issued Share Capital

Shares actually issued to the general public from authorized capital e.g. 40,000
shares x £1 = £40,000

3) Called Up Share Capital

The amount called up by the owners from the shareholders e.g. 40,000 shares x
£0.75 = £30,000

4) Paid Up Share Capital

Amount actually received by the owners (after deducting formation expenses) e.g.
40,000 shares x £0.7 = £28,000
So at the issue of shares, Balance Sheet would be like this:
£
Authorised Capital 50,000
Issued Capital 40,000
Called up share 30,000
capital
Cash 28,000
Formation expenses 2,000
Total Assets 30,000

Preference Shares/Preferred Stock

A share which entitles the holder to a fixed dividend, whose payment takes
priority over that of ordinary share dividends. Priority is also given to preference
shareholders over ordinary shareholders in liquidation payments. It is mainly
issued to generate funds.

Types of Preference Shares

1) Redeemable Preference Shares

These are redeemable after the expiry of a fixed period. It is treated as a non-
current liability. For redeemable preference shares preference dividend is a part
of finance cost in profit and loss account and preference shares are shown under
fixed liabilities in balance sheet.

2) Irredeemable Preference Shares

These shares are not redeemable. These are treated as equity of the company.
Its dividend is treated as an appropriation from profit after tax (PAT).

3) Participative Preference Shares

These shares give the right to shareholders to participate in profits beyond the
stated rate of dividends i.e. getting profit share from unexpected gains.
Debentures/Loan Stock
Debenture is a medium- to long-term debt instrument used by companies to
borrow money, at a fixed rate of interest. It is mainly issued to generate funds.

Types of Debentures

1) Redeemable

Redeemable at the end of a fixed period.

2) Irredeemable

Not redeemable after the expiry of fixed period (no fixed time to pay them).

3) Convertible

Loan will be settled by issuing shares at the end of a fixed period 3 years (i.e. loan
convertible into shares after 3 years)

Points of Ordinary shares Preference Debentures

difference shares
Voting rights Carry voting right Do not carry Do not carry
voting rights voting rights
Status Owners/members Preference Debenture
of the company shareholder holders/long
term creditors
Income Ordinary Preference Debenture
dividends dividends (fixed) interest (fixed)
(depends upon
profits)
Risk Most risky Medium risky Least risky
nd
Liquidation Last preference 2 preference 1st preference
nd
payments (paid at last) (paid 2 ) (paid 1st)
Share Value Terms

Nominal/Face Value

The value printed on the face of share e.g. £1, £0.5 etc.

Market Value

The value at which share is traded in stock exchange e.g. £5, £10 etc.

Fair Value

The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.

Issue of Shares
Issue of Shares

At Par AT Premium At Discount

Shares issued at par Shares issued over the Shares issued below the
value i.e. face value. face value. face value.
Issue Price = £1 Issue Price = £3 Issue Price = £0.90
Face value = £1 Face value = £1 Face value = £1
Premium profit = £2 Discount loss = £0.10

Example
A Ltd issued 100 ordinary shares (nominal/face value £1.00). Show the entries of
how shares will be recorded at if issued:
(i) at a premium of £2 per share,
(ii) at a discount of £0.3 per share
(iii) at par value
Answer
(i) Cash received on issue of shares = 100 shares x £3 = £300

Dr Cash 300 (100 x 3)

Cr Share Capital 100 (100 x 1)
Cr Share Premium 200 (100 x 2)

(ii) Cash received on issue of shares = 100 shares x £0.7 = £70

Dr Cash 70 (100 x 0.7)
Dr Discount on issue of shares 30 (100 x 0.3)
Cr Share Capital 100 (100 x 1)

(iii) Cash received on issue of shares =100 shares x£1= £100

Dr Cash 100 (100 x 1)
Cr Share Capital 100 (100 x 1)

Reserves

Capital Reserves Revenue Reserves

Required by law. Not required by law.
Not distributable. Distributable for dividend
Examples: share premium, payments.
revaluation surplus, non-current Examples: general reserves,
asset replacement reserve retained profits etc
debenture redemption reserve, etc Can be used for bonus issue
Can be used for bonus issue

Corporation Tax

A corporate tax is tax on the profits of a corporation. It is paid on

company’s operating earnings. It is shown in income statement after PBT. It can
be of two types:
1) Current tax

 Payable/Recoverable in the next year

 Deducted/added in PBT
 Current liability/asset

2) Deferred Tax

 Payable/Recoverable after one year

 Deducted/added in PBT
 Non-Current liability/asset

DIVIDENDS
It is the amount paid to shareholders at year end upon their investments. It is
shown in statement of changes in equity as a deduction from retained profits.

Types Ordinary Preference Interim Final/Proposed

dividend dividend dividend dividend
Explanation Paid in the Paid in the Paid in the Payable next
current year on current year on current year year.
ordinary shares preference
on interim Announced in
shares
basis upon the current
any year.
unexpected
gains. (For
e.g. sale of
non-current
asset).
Presented In Trail balance In Trail balance In Trail In Adjustments
balance
Accounting Shown as a If redeemable Shown as a Disclose by a
treatment deduction from then shown as a deduction note under
PAT in SOCIE finance cost. If
from PAT in SOFP
irredeemable
then shown as a SOCIE
deduction from
PAT in SOCIE