topic 20 introduction to limited companies

• Limited companies introduction:

  • sole traders are the most common type of business, however one person is unlikely to be able to raise enough finance to invest in large amounts of assets
  • where large amounts of finance need to be raised a group of people can share the ownership of the business so that the capital of a limited company is divided into shares and is therefore known as share capital
  • to become a shareholder a person must buy at least one share in the company and the shareholders then form a limited company
• Types of company:

  • private limited company - known as Ltd, share issue is restricted to family and friends and shares can not be listed or traded on the stock market
  • public limited companies - known as Plc, can raise finance by selling shares to the general public and shares can be listed and traded on the stock market
• Shareholders own limited companies but appoint paid directors to run the company on their behalf. Shareholders' interests are protected by a number of laws to ensure that they do not lose out financially. Unlike sole traders:

  • a company has a separate legal entity to its shareholders, it can sue or be sued and pays corp. tax
  • a company has continuity - it has a separate existence to its owners
  • the shareholders in a company benefit from limited liability
• Limited liability:

  • shareholders of a company can only lose the amount of their investment
  • only company assets can be sold to repay company liabilities
  • in the event of the company becoming insolvent, the shareholders' personal assets cannot be used to pay off the company's liabilities
• Company income statement:

  • director's remuneration (income from the company) is an expense
  • auditor's fees are an expense
  • finance costs/interest are minused from profit from operations
  • profit for the year before tax is the same as profit for the year for a sole trader
  • tax is minused from profit for the year before tax
• Company income statement:

  • other operating income eg. rent/commission received is treated the same as for a sole trader
  • non-operating income eg. interest/dividends/discount received is included after profit from operations before finance costs
• A company SOFP:

  • the top half of the SOFP is similar to a sole trader
  • however, companies will have some liabilities which would not appear on the balance sheet of a sole trader such as debentures and tax
  • equity: similar to capital account but is made up of ordinary share capital and reserves
• Share capital:

  • a company raises share capital through the issue of shares in exchange for money to enable it to buy assets
  • the shareholders may then receive an annual share of the profit for the year, known as a dividend
  • the most common type of shares are ordinary shares, the annual dividend can vary and is recommended by the company directors
• Authorised share capital - what they are permitted to issue
• Issued share capital - what they have actually issued
• Nominal value:

  • means 'in name only'
  • also known as face value and par value
  • it is the value at which the shares are placed in the ledger accounts and on the balance sheet
  • it is not necessarily the price at which the shares were sold - this is the issue price or what they are worth, this is the market price
• Legal background:

  • a company is formed through a process known as incorporation
  • the company completes two legal documents which are filed with the registrar of companies: memorandum of association and articles of association
• Dividends:

  • sole traders take a share of the profit for the year in the form of drawings, similarly the shareholders in a limited company may be entitled to an annual share of the profit for the year known as a dividend
  • only dividends paid during the accounting period are included in the financial statements, proposed dividends are not recorded
• Reserves:

  • increases in the worth of the company over and above its share capital are known as reserves
  • reserves are not cash or money in the bank, so they are not money available to spend
• Revenue reserves - occur due to the normal trading activities of the company which are calculated in the IS and enable the company to have retained earnings
• Capital reserves - occur due to the transactions which are not part of the company's normal trading activities and affect the SOFP