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Chapter 6
Introduction to limited companies
Choose the one alternative that best completes the statement or answers the question.
1) Which of these is not a consequence of the status of a company as a separate legal entity?
A) The right to retain profits
B) The obligation to pay taxation
C) The right to enter into contracts in its own name
D) None of the above, i.e., all are consequences of the status of a company as a separate legal entity
Answer: D
Difficulty: Moderate
Learning Objective: 6.1 Identify and discuss the main features of companies.
Topic: The main features of companies
AACSB: 3 Analytical thinking
2) Limited liability means:

A) the liability of shareholders for company debts is normally limited to the amount they have paid for
their shares.
B) the liability of directors for company debts is limited.
C) if the company fails, the creditors may have to bear greater losses than if they were dealing with a non-
company.
D) Both A and C
Answer: D
3) Which feature is not a characteristic of a company?

A) Limited liability
B) Less government regulation than other types of entities
C) Legal entity
D) Perpetual life
Answer: B
Difficulty: Basic
Copyright © 2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781488616570/Atrill/Accounting for
Business Students/1e
4) Which of the following is a legal entity?
A) Company
B) Partnership
C) Sole proprietorship
D) All of the above
Answer: A
Difficulty: Basic
5) Which of these is not an advantage of a private company compared to a partnership?

A) Perpetual life
B) Easier transfer of ownership
C) Limited liability
D) Mutual agency
Answer: D
Difficulty: Basic
6) Which is the highest level of control in a company?

A) Board of directors
B) Chief financial officer
C) Executive officer
D) Chief accountant
Answer: A
Difficulty: Basic
7) The shareholders that are eligible to vote for the board of directors of a company are:
A) all shareholders holding more than 1 000 shares.
B) all shareholders who attend the annual general meeting.
C) all shareholders holding voting shares.
D) all preference shareholders.
Answer: C
Difficulty: Basic
8) Which statement is untrue for private (Pty Ltd) companies?

A) They tend to be associated with smaller businesses
B) There are fewer private companies in Australia than public companies
C) They are less regulated than public companies
D) The shareholders are often family members
Answer: B
Difficulty: Complex
9) The company ‘Raider Limited’ must be:

A) a proprietary company.
B) a public company.
C) a private company.
D) none of the above.
Answer: B
Difficulty: Basic
AACSB: 8 Application of knowledge
10) Which type of company has the right to raise money from the general public?
A) Proprietary company
B) Public company
C) Private company
D) All of the above
Answer: B
11) Which type of company operating under the Corporations Act 2001 must have the words Proprietary
Limited (Pty Ltd) after its name?
A) Proprietary company
B) No liability company
C) Company listed on the stock exchange
D) Public company
Answer: A
Difficulty: Basic
12) Under the Corporations Act 2001, a proprietary (Pty Ltd) company is restricted to a maximum of:
A) 100 shareholders.
B) 2 shareholders.
C) 50 shareholders.
D) 10 shareholders.
Answer: C
13) Small proprietary companies are relieved of many of the reporting requirements to which public
companies are subject. A company is deemed to be ‘small’ if it satisfies two of three specified criteria.
Which of the following is not one of the criteria?
A) It has consolidated gross profits of less than $30 million.
B) Its consolidated gross assets at the end of the financial year are less than $12.5 million.
C) It employs fewer than 50 employees at the end of the financial year.
D) It has consolidated gross operating revenue of less than $25 million
Answer: A
Difficulty: Complex
14) What is the main stock exchange in Australia?

A) NASDAQ
B) ASX
C) DAX
D) ASIC
Answer: B
Difficulty: Complex
15) Which of the following is not a rule in the framework used for monitoring and controlling the
behaviour of company directors?
A) Subjectivity
B) Disclosure
C) Fairness
D) Accountability
Answer: A
16) The disadvantages of a company business structure include all of the following except:
A) extensive regulatory requirements.
B) more expensive to establish.
C) less management flexibility.
D) mutual agency.
Answer: D
17) Additional regulations that may apply to limited companies (depending on their classification) do not
include requirements relating to:
A) the audit of annual reports by a registered auditor.
B) a limited number of employees.
C) the submission of annual reports to ASIC.
D) preparation of annual reports in accordance with accounting standards.
Answer: B
Difficulty: Complex
Write your answer in the space provided or on a separate sheet of paper.
18) Jane and Jarrod have been employed by two different firms of photographers. They decide they
should get together and establish their own business, called JJ Photographers. Each has decided to
contribute $20 000 in cash to buy equipment, and they will rent premises in the local shopping centre.
Both will work full time in the business and share profits and losses equally. They are not sure whether
they should set up as a partnership or as a private company and have come to you for advice.
REQUIRED:
Explain to Jane and Jarrod the advantages and disadvantages of a partnership versus a private company
structure for their new venture.
_____________________________________________________________________________________________
_____________________________________________________________________________________________
Answer:
Advantages of a partnership (disadvantages of a company)
1. A partnership is easier to form than a company. It can be as simple as a verbal agreement, although it is
recommended that there is a written partnership agreement. There is a lot more paperwork involved in
setting up a company
2. Because it is easy to establish, it is cheap to form a partnership. The costs to organise a company are
greater, and there are higher ongoing costs as well to maintain the structure.
Disadvantages of a partnership (advantages of a company)
1. A partnership has a limited life, as it ceases upon any change in the number of partners. A company, by
contrast, has a perpetual life at law and will continue indefinitely independent of changes in shareholders
or directors.
2. A disadvantage of a partnership compared to a company is that the partners have unlimited liability.
This means they are liable to the full extent of their private assets for all partnership debts. With a
company, the owners (shareholders) are liable only for what they have contributed to the business as
share capital, i.e., they have limited liability. If Jane and Jarrod anticipate substantial credit purchases
such as extra equipment or supplies, borrowing money or incurring other sorts of credit obligations, they
need to think seriously about limited liability. However, in practice the protection offered is not as good
as it sounds as substantial lenders, such as banks or finance companies, require personal guarantees from
owners, which negates limited liability. Forming a company would provide some relief to Jane and Jarrod
in the case of smaller credit debts, if the business were to get into serious financial difficulties.
3. Transfer or extension of ownership is not as easy with a partnership as with a company. Companies,
through the issue of shares, provide a mechanism for the sale of an ownership interest or the introduction
of new capital. This means that if, at some later stage, either Jane or Jarrod want to sell their share of the
business or need to source extra funds, it would be easier with a company structure.
4. There is less scope for tax minimisation and tax planning with a partnership than with a company.
However, in practice, when starting up a business which initially has low levels of profit, a good
accountant should be able to ensure that the tax paid is similar regardless of the type of structure.
In summary, on the points raised, it seems that Jane and Jarrod will have to decide on the trade-off
between the greater costs of setting up and running a company structure versus the advantages of limited
liability. The issue of ease of transfer of ownership is probably not an immediate one. As Jane and Jarrod
are starting out on a small scale, they may prefer to avoid high establishment costs and begin as a
partnership. The decision on business structure is not irrevocable. Many businesses start off as a
partnership and as they grow, take the step to incorporate.
Difficulty: Complex
AACSB: 1 Written and oral communication
19) A company issued 500 000 ordinary shares to the public, priced at $1. The shares were payable 50
cents on 1 July 2018 and 50 cents was uncalled. How much cash was due to the company on 1 July from
the issue?
A) $150 000
B) $300 000
C) $100 000
D) $250 000
Answer: D
Difficulty: Basic
Learning Objective: 6.2 Explain equity and borrowings in a company context.
Topic: Equity and borrowings in a company context
20) A company issued 120 000 fully paid, 5% preference shares priced at $2 each. The dividend to be paid
on the shares for a financial year is:
A) $5 000
B) $10 000
C) $20 000
D) $12 000
Answer: D
Difficulty: Basic
21) Which item(s) can be a component of shareholders’ equity?

A) Retained profits
B) Share capital
C) Reserves
D) All of the above
Answer: D
Difficulty: Basic
22) Which statement relating to preference shares is not correct?

A) They are often non-voting shares.
B) They are generally more risky for shareholders to own than ordinary shares.
C) They are entitled to receive a dividend before the ordinary shareholders.
D) They normally have a fixed rate of dividend attached.
Answer: B
23) A company needs $3 000 000 for expansion. They decide to raise the capital by issuing new shares.
How many shares does the company need to sell to raise the amount, if the last share issue was at a price
of $1 each and the current market price for the company’s shares is $1.50 per share?
A) 500 000 shares
B) 100 000 shares
C) 1 million shares
D) 2 million shares
Answer: D
Difficulty: Complex
24) In a company statement of financial position, the balance of retained profit at the end of the period is
equal to:
A) profit for the period.
B) retained profit at the beginning of the period plus profit minus dividends declared.
C) profit less losses.
D) retained profit at the beginning of the period plus profit.
Answer: B
25) If the retained profit figure in a company statement of financial position increases from the beginning
of the year to the end of the year, it is most probable that:
A) profit for the year is less than dividends declared.
B) bonus shares have been issued.
C) additional capital has been raised during the year.
D) profit for the year is more than dividends declared.
Answer: D
Difficulty: Complex
26) The largest source of new finance for Australian companies is:
A) retained profits.
B) share issues.
C) bank loans.
D) revaluations.
Answer: A
27) What are bonus shares?

A) Shares issued to employees
B) Shares issued at no cost to shareholders
C) Shares issued to the board of directors
D) Shares issued to valued customers
Answer: B
Difficulty: Basic
28) Which is the main government regulator of companies in Australia?

A) The Australian Securities and Investments Commission
B) The Auditors Board
C) The Australian Securities Exchange
D) The Australian Accounting Standards Board
Answer: A
29) A shareholder in Company C owns 2 000 shares bought for $1 each. The company decides to make a
bonus issue of one new share for every two existing shares held. How many shares does the shareholder
now have in Company C?
A) 3 000 shares
B) 1 500 shares
C) 500 shares
D) 1 000 shares
Answer: A
30) A bonus issue of shares by a company will:

A) increase total shareholders’ equity.
B) sometimes increase shareholders’ equity and sometimes leave it unchanged.
C) leave total shareholders’ equity unchanged.
D) reduce total shareholders’ equity.
Answer: C
Difficulty: Complex
31) An investor invests in Canta Ltd by purchasing 2 000 shares for $2.50 each. In the following year, the
company distributes a 1 for 1 share dividend (bonus issue). After the issue, the number of shares held by
the investor:
A) will increase by 200 and the market price of the shares will fall.
B) will increase by 2 000 and the market price of the shares will remain the same.
C) will increase by 2 000 and the market price of the shares will rise.
D) will increase by 2 000 and the market price of the shares will fall.
Answer: D
Difficulty: Basic
32) A share issue where the company gives existing shareholders the first right of refusal of the issue is:
A) an ordinary issue.
B) a bonus issue.
C) a rights issue.
D) a preference issue.
Answer: C
33) If a company has a share capital of $150 000, revenue reserves of $25 000 and retained profits of $50
000, what is the maximum amount it can legally distribute as cash dividends?
A) $130 000
B) $75 000
C) $145 000
D) $30 000
Answer: B
Difficulty: Basic
34) If a company issues 25 000 ordinary shares which are sold at $4 per share, the effect on the accounting
equation is:
A) increase cash $100 000; decrease in shareholders’ equity $80 000.
B) increase cash $100 000; increase in liabilities $80 000.
C) increase cash $100 000; increase in shareholders’ equity $100 000.
D) none of the above.
Answer: C
Difficulty: Basic
35) Which statement concerning a rights issue is true?

A) The issue is often made to ensure that new shareholders are brought into the company.
B) The shares are generally offered at above the current market price of the existing shares.
C) The cost of the issue tends to be less than making a share issue to the general public.
D) Both A and C
Answer: C
36) The offer of new shares to existing shareholders at no cost, in proportion to the amount of their
current holding, is known as:
A) a preference issue.
B) a bonus issue.
C) an option.
D) a rights issue.
Answer: B
Difficulty: Basic
37) A bonus issue of shares will result in:

A) an increase in cash at bank.
B) an increase in the number of issued shares.
C) an increase in shareholders’ equity.
D) All of the above
Answer: B
Difficulty: Complex
38) Which of the following is not a reason for a company making a bonus issue of shares?
A) To use cash.
B) As a signal to the market of the company’s confidence in its future.
C) To reduce its share price when it has become too high.
D) None of the above, i.e., all are reasons for making a bonus issue
Answer: A
39) Shareholders who exercise their entitlement to a bonus issue of shares, in theory, will:
A) leave their wealth unchanged.
B) reduce their proportional ownership in the company.
C) increase their wealth.
D) reduce their wealth.
Answer: A
Difficulty: Complex
40) A public issue of shares where the investor must state in advance the amount they are willing to pay
for the shares is called a:
A) tender issue.
B) private issue.
C) share purchase plan.
D) venture share issue.
Answer: A
Difficulty: Complex
41) Sovereign Ltd has an issued capital of 300 000 000 shares sold at $2 each. Aman holds 9 000 shares. If
Sovereign Ltd makes a 1 for 3 bonus issue, how many bonus shares will Aman acquire?
A) 3 000 shares
B) 1 800 shares
C) 2 000 shares
D) 9 000 shares
Answer: A
Difficulty: Basic
42) The part of shareholders’ equity that may not be used to pay cash dividends is:
A) retained profits.
B) share capital.
C) revenue reserves.
D) Both A and B
Answer: B
Difficulty: Basic
Learning Objective: 6.3 Explain the restrictions on the rights of shareholders regarding drawings or
reductions in capital.
Topic: Restrictions on the rights of shareholders to make drawings or reductions of capital
43) Which of the following factors does not influence a firm’s dividend decision?
A) A desire to have good investor relations
B) Cash available to pay a dividend
C) Wanting to reduce paid-up capital
D) The need for finance for an investment
Answer: C
Difficulty: Basic
44) Why is a company required to retain a specific part of its capital?

A) Protect the company’s creditors
B) Enable the payment of future dividends
C) Facilitate a non-current asset replacement plan
D) Use as security for future loans
Answer: A
45) Redeemable preference shares:

A) are the same as bonus shares.
B) can be repurchased by the company.
C) allow the holders full voting rights.
D) can be exchanged for ordinary shares.
Answer: B
46) Which of the following statements is correct?

A) Most companies see retained profits as the least likely source of finance.
B) The law quite clearly specifies the size of the non-distributable portion of capital a firm must hold
back.
C) Preference capital redeemed by a company is always held in retained profits.
D) A company is not allowed to acquire and hold its own shares.
Answer: D
47) Which general standard of reporting must financial accounts prepared by companies under the
Corporations Act 2001 meet?
A) Accurate
B) Satisfactory
C) True and fair
D) Beyond a reasonable doubt
Answer: C
Learning Objective: 6.4 Explain and discuss the main financial statements prepared by a limited
company.
Topic: The main financial statements
AACSB: 2 Ethical understanding and reasoning
48) Which report is specifically designed to provide an assessment of the credibility and reliability of the
financial statements a company issues for external use?
A) Audit report
B) Director’s statement
C) Director’s report
D) Trustee statement
Answer: A
Difficulty: Basic
company.
49) Which of these is a disadvantage of a country adopting international accounting standards compared to
the country developing its own standards?
A) Standards by their nature must be general and involve compromises.
B) It will increase accounting and reporting costs for multinational companies.
C) It will reduce the comparability of different countries’ financial reports.
D) All are disadvantages
Answer: A
Difficulty: Complex
company.
50) What is the main difference between the financial statements prepared for a sole proprietorship and
those prepared for a company?
A) The number of statements that must be prepared
B) The detail in the reports
C) Sole proprietorship’s reports are always prepared at the end of December
D) Companies do not have to prepare a cash flow statement
Answer: B
Difficulty: Basic
company.
51) The shareholders’ equity section in a statement of financial position may include which of the
following accounts?
A) Retained profits
B) Share capital
C) Reserves
D) All of the above
Answer: D
Difficulty: Complex
company.
52) In what order do the following items appear in a company’s statement of financial performance?
1. Tax expense
2. Revenue
3. Gross profit
4. Operating profit
5. Cost of sales
A) 1, 2, 3, 5 & 4
B) 2, 3, 5, 1 & 4
C) 2, 5, 3, 1, & 4
D) 2, 5, 3, 4 & 1
Answer: D
Difficulty: Complex
company.
AACSB: 1 Written and oral communication
53) Assume the balance in the retained profit account 03/06/2017 is $55 000. The profit for 2017/18 is $35
000 and dividends declared are $40 000. What is the balance in retained profits 03/06/2018?
A) $49 000
B) $89 000
C) $50 000
D) None of the above
Answer: C
Difficulty: Complex
company.
54) If the tax rate is 30%, interest expense is $15 000 and operating profit is $82 000, what is the profit for
the year?
A) $63 000
B) $44 100
C) $46 900
D) None of the above
Answer: C
Difficulty: Complex
company.
55) An audit fee expense will most likely be found in the statement of financial performance for a:
A) Sole proprietorship
B) Partnership
C) Company
D) Both B and C
Answer: C
company.
56) Which of the following is unlikely to be a reserve found in a company’s statement of financial
position?
A) Asset replacement
B) Foreign currency
C) Acquisition
D) All of the above are likely to be found
Answer: D
Difficulty: Complex
company.
57) How are dividends that have been declared and authorised but remain unpaid at the end of the year,
recorded in the statement of financial position?
A) As a current asset
B) As a current liability
C) As a non-current liability
D) As a non-current asset
Answer: B
Difficulty: Basic
company.
58) If operating profit is $131 000, tax expense is $39 000 and profit for the year is $82 000, what is the
interest expense?
A) $43 000
B) $49 000
C) $10 000
D) Unable to be calculated
Answer: C
Difficulty: Complex
company.
59) Which of the following equations relating to a company’s statements of financial performance is
incorrect?
A) Operating profit - Interest = Profit before tax
B) Revenues - Cost of sales = Gross profit
C) Profit before tax - Tax expense = Profit for the period
D) Gross profit - Tax expense - Interest expense = Operating profit
Answer: D
Difficulty: Complex
company.
60) Which of the following statements in relation to dividends is true?

A) Dividends represent drawings by the owners (shareholders) of the company.
B) Dividends can be paid out of any equity account.
C) Shareholders must be paid an annual dividend regardless of the type of share they hold.
D) A company cannot declare both an interim and a final dividend.
Answer: A
Difficulty: Basic
company.
Write your answer in the space provided or on a separate sheet of paper.

61) The shareholders are the owners of a company. The shareholders’ equity of Adventure Travel Agency
Pty Ltd is set out below. (Note that all shares were issued when the company was originally set up and
there have been no subsequent issues.)
Adventure Travel Agency Pty Ltd

Statement of Financial Position (extract) as at 30 June 2018
Shareholders’ equity
Share Capital -
60 000 ordinary shares sold for $10 each $600 000
Retained profits 20 000
General reserve 12 000
Asset revaluation reserve 180 000
Total equity $812 000
REQUIRED:
a) Briefly explain the meaning of each of the four components of shareholders’ equity, giving an example
of how each might have arisen.
b) Indicate which of the four components are legally available for the payments of cash dividends.
_____________________________________________________________________________________________
_____________________________________________________________________________________________
Answer:
a) Share capital is the cash contributed by the people who established Adventure Travel Agency Pty Ltd.
Each of these individuals has used their money to buy units of ownership in the company, of equal value,
known as shares. In all, 60 000 shares have been sold at a price of $10 each, giving a total contributed
capital of $600 000. Shareholders can receive dividends on their shares from profits earned. Ordinary
shares normally carry an entitlement to vote for the Board of Directors who will oversee the management
of the company.
Retained profits of $20 000 represent all the profits that have been earned (minus losses) since
incorporation, less any dividends that have been paid out to the shareholders and less any amounts that
have been transferred to reserves such as the general reserve. Retained profits tend to be accompanied by
cash flowing into the company but they themselves do not specifically represent cash, rather they are
represented by all the assets of the business in their various forms, e.g., stock, accounts receivable and
fixed assets as well as cash.
The general reserve is a subgroup of retained profits. It represents a transfer from retained profits which
is made through an accounting entry to indicate that the current intention of the company is to plough
these profits back into the business, rather than have them available for the payment of dividends to
shareholders. Dividends can legally be paid from revenue reserves like the general reserve but, by
renaming a portion of retained profits to general reserve, the directors are signalling that it is not their
current intention to use these profits for dividends.
The asset revaluation reserve is not a reserve that is a subcategory of retained profits, but it arises from
the revaluation of assets. For example, Adventure Travel Agency Pty Ltd might have bought land and
buildings a number of years ago for, say $400 000, but over time the estimated market value of the
property will have increased. To reflect the opinion that there has been a permanent increase in the value
of the property, it can be revalued upwards in the statement of financial position through an increase in
the value of land and buildings, and the creation of an asset revaluation reserve that increases
shareholders’ equity.
b)
• The share capital is not legally available for the payment of cash dividends.
• Cash dividends can be legally paid from retained profits.
• Dividends can be legally paid from revenue reserves like the general reserve.
• The estimated capital gain represented by the $180 000 in the Asset Revaluation Reserve is not legally
available for the payment of cash dividends to the shareholders as, at this stage, it is an unrealised gain.
The asset revaluation reserve is sometimes used for the payment of a non-cash dividend which is
satisfied by the issue of bonus shares.
Difficulty: Complex
company.
62) To what extent must the revenues, expenses, assets, and liabilities of a subsidiary company be
reflected in the group financial statements?
A) Their full extent
B) The proportion owned by the parent company
C) The proportion not owned by the parent company
D) They are not included
Answer: A
Difficulty: Basic
Learning Objective: 6.5 Explain the concept of group or consolidated accounts.
Topic: Accounting for groups of companies
AACSB: 7 Reflective thinking
63) Parco pays $1 000 000 for all of Subco’s common shares. Subco’s net assets are carried on Subco’s
books for $900 000 and have a fair value of $950 000. What is Parco’s goodwill on consolidation?
A) $50 000
B) $100 000
C) Zero
D) Cannot be determined from the information given.
Answer: A
64) Which of the following accounts only appears on group financial statements?
A) Non-controlling interest
B) Amounts receivable by a parent company from a subsidiary
C) Profit earned by a subsidiary from a sale made to its parent
D) Total group revenue
Answer: A
Difficulty: Basic
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2) Limited liability means:

3) Which feature is not a characteristic of a company?

5) Which of these is not an advantage of a private company compared to a partnership?

6) Which is the highest level of control in a company?

8) Which statement is untrue for private (Pty Ltd) companies?

9) The company ‘Raider Limited’ must be:

14) What is the main stock exchange in Australia?

Write your answer in the space provided or on a separate sheet of paper.

Disadvantages of a partnership (advantages of a company)

21) Which item(s) can be a component of shareholders’ equity?

22) Which statement relating to preference shares is not correct?

27) What are bonus shares?

28) Which is the main government regulator of companies in Australia?

30) A bonus issue of shares by a company will:

35) Which statement concerning a rights issue is true?

37) A bonus issue of shares will result in:

44) Why is a company required to retain a specific part of its capital?

45) Redeemable preference shares:

46) Which of the following statements is correct?

60) Which of the following statements in relation to dividends is true?

Write your answer in the space provided or on a separate sheet of paper.

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