IGCSE Accounting Ch 17: Limited Companies

Cambridge IGCSE Accounting

Limited Companies

This chapter explains limited company accounting, including shareholders, limited liability, shares, dividends, ordinary and preference shares, reserves, issued/called-up/paid-up share capital, debentures, company income statements, statements of changes in equity, dividends, statement of financial position and year-end adjustments.

Limited liabilityShareholdersSharesDividendsReservesShare capitalDebenturesEquity

Limited company overview showing shareholders, directors, equity, dividends and debentures

Topic 1: Limited Company Basics

A limited company is owned by shareholders, but it has a separate legal identity from its owners.

1. What is a Limited Company?

A limited company is a business owned by shareholders.

Unlike a sole trader or ordinary partnership, the company has a separate legal identity from its owners.

Shareholders have limited liability, meaning they normally risk only the amount they have invested in the company’s shares.

Example
A shareholder owns 10 shares × $100 = $1,000.
If the company fails, the shareholder’s liability is limited to the $1,000 investment.

2. Advantages and Disadvantages

Advantages

Shareholders have limited liability.
It is easier to raise large amounts of capital.
The company can issue shares to investors.
It may find it easier to obtain loans.
It is often easier to recruit employees.

Disadvantages

There are more legal requirements.
The company must be registered.
Financial statements must be published.
There is less financial secrecy.
Shareholders do not normally manage the company directly.
Directors may make decisions that shareholders disagree with.

The shareholders elect a board of directors to manage the company, so ownership and management are separated.

3. Shares and Shareholders

A share is a unit of investment in a company.

Shareholder

A shareholder is a person or institution that owns one or more shares.

Shares have a nominal value or face value, for example:

4. Equity

Equity represents the shareholders’ financial interest in the company.

The chapter describes company equity as being made up of share capital and reserves.

Ordinary share capital

Main ownership capital.

Preference share capital

Shares with a fixed dividend preference.

General reserve

Profits transferred for future needs.

Retained earnings

Profit kept in the company after dividends and transfers.

5. Dividends

A dividend is part of the company’s profit distributed to shareholders.

Example
Share capital = $500,000
Shares have nominal value = $10 each
Number of shares = $500,000 ÷ $10 = 50,000 shares
Total dividend = $150,000
Dividend per share = $150,000 ÷ 50,000 = $3
Dividend rate = $150,000 ÷ $500,000 × 100 = 30%

Topic 2: Ordinary Shares, Preference Shares and Reserves

Different types of shares give shareholders different rights to dividends, repayment and voting.

6. Ordinary Shares

Ordinary shareholders are the main owners of the company.

They normally have voting rights.
They receive dividends after preference shareholders.
They may receive different dividend amounts depending on profits.
They are normally paid last if the company is wound up.

After creditors, debenture holders and preference shareholders have been paid, any remaining assets belong to the ordinary shareholders.

7. Preference Shares

Preference shareholders have certain advantages over ordinary shareholders.

They normally receive dividends at a fixed percentage.
They receive their dividend before ordinary shareholders.
They receive repayment of capital before ordinary shareholders if the company closes.
They do not normally have voting rights at the annual general meeting.

Example
5% preference shares = $20,000
Dividend = 5% × $20,000 = $1,000
The preference shareholders receive $1,000 before ordinary dividends are paid.

8. Ordinary vs Preference Shares

Ordinary Shares	Preference Shares
Dividend may vary.	Fixed-rate dividend.
Paid dividend after preference shareholders.	Paid dividend first.
Usually voting rights.	Usually no voting rights.
Repaid last on winding up.	Repaid before ordinary shareholders.

9. Reserves

Reserves are profits retained in the company rather than distributed to shareholders.

Retained Earnings

Profit kept in the company after dividends and transfers to reserves. It can be used for future needs and growth.

General Reserve

Profit transferred into a reserve for purposes such as future expansion or possible future liabilities.

Topic 3: Share Capital and Debentures

Share capital is ownership finance. Debentures are loan finance and must be treated differently.

10. Issued Share Capital

Issued share capital is the nominal value of shares the company has issued.

Example
100,000 shares × $1 each
Issued share capital = $100,000

11. Called-Up Share Capital

A company may not ask shareholders to pay the full nominal value immediately. The amount the company asks shareholders to pay is called called-up capital.

Example
100,000 shares of $1 each are issued.
The company calls up only $0.60 per share.
Called-up capital = 100,000 × $0.60 = $60,000

12. Paid-Up Share Capital

Paid-up capital is the amount of called-up capital that shareholders have actually paid.

Example
Called-up capital = $60,000
Shareholders have failed to pay = $2,000
Paid-up capital = $60,000 − $2,000 = $58,000

The textbook illustrates this distinction with issued, called-up and paid-up share capital.

13. Full Share Capital Example

A company issues 250,000 shares of $1 each. Shareholders are asked to pay $0.25 per share. $500 remains unpaid.

Issued Capital250,000 × $1 = $250,000

Called-Up Capital250,000 × $0.25 = $62,500

Paid-Up Capital$62,500 − $500 = $62,000

14. Debentures

A debenture is a form of long-term loan capital. Debenture holders are creditors, not owners.

They receive a fixed rate of interest.
They do not normally have voting rights.
They must receive interest whether the company makes a profit or loss.
They are repaid before shareholders if the company is wound up.

Debentures are normally shown as a non-current liability.

15. Debenture Interest

Debenture interest is a finance cost in the income statement.

Example
10% debenture = $100,000
Annual interest = 10% × $100,000 = $10,000
The company must pay the $10,000 even if it makes a loss.

16. Shares vs Debentures

Shares	Debentures
Equity capital.	Loan capital.
Shareholders are owners.	Debenture holders are creditors.
Ordinary shareholders can vote.	Debenture holders cannot vote.
Dividends depend on company circumstances.	Interest must be paid.
Part of equity.	Liability.
Shareholders repaid later.	Debenture holders repaid before shareholders.

Topic 4: Company Income Statement and Changes in Equity

Limited company financial statements include grouped expenses and a statement showing movements in equity.

17. Company’s Income Statement

The basic trading section is similar to that of a sole trader. However, company expenses are grouped into three categories.

Administration Expenses

Office salaries, rent, depreciation of office equipment.

Selling and Distribution Expenses

Advertising, carriage outwards, sales staff salaries, depreciation of delivery vehicles and irrecoverable debts.

Finance Costs

Debenture interest.

18. Simple Company Income Statement

Suppose gross profit is $100,000, administration expenses are $25,000, selling and distribution expenses are $20,000, and debenture interest is $5,000.

Income Statement Extract

Gross profit$100,000

Less: Administration expenses($25,000)

Less: Selling and distribution expenses($20,000)

Profit before interest$55,000

Less: Debenture interest($5,000)

Profit for the year$50,000

Statement of changes in equity retained earnings example

19. Statement of Changes in Equity

A limited company prepares a statement of changes in equity. It explains why equity increased or decreased during the year.

Opening share capital

Capital at the start of the year.

New shares issued

Share capital added during the year.

Opening reserves

Reserves at the start of the year.

Profit for the year

Profit added to equity.

Interim dividends paid

Distributions deducted from retained earnings.

Closing totals

Closing retained earnings and total equity.

It may also include transfers to general reserve.

20. Simple Statement of Changes in Equity Example

Opening retained earnings are $20,000. Profit for the year is $50,000. Interim dividend paid is $10,000. Transfer to general reserve is $15,000.

Closing retained earnings = $20,000 + $50,000 − $10,000 − $15,000 = $45,000

The transfer to general reserve does not reduce total equity; it simply moves an amount from retained earnings into another reserve.

21. Interim and Proposed Dividends

Interim Dividend

A dividend paid during the financial year. It appears in the statement of changes in equity.

Proposed Final Dividend

A dividend recommended but not yet approved or paid.

In the treatment used by this textbook, a proposed dividend is not included in the financial statements. It is mentioned only in a note, so it is not shown as a current liability.

Topic 5: Statement of Financial Position, Adjustments and Exam Guide

The main difference from sole trader accounts is the equity section, which shows share capital and reserves.

22. Statement of Financial Position

The assets section is similar to that of a sole trader. The major difference is the equity section.

Equity Example

Ordinary share capital$100,000

General reserve$50,000

Retained earnings$30,000

Total equity$180,000

Non-current liability

Debentures = $80,000.

Current liabilities

Trade payables = $20,000 and accrued debenture interest = $4,000.

23. Accrued Debenture Interest

Sometimes only part of the year’s debenture interest has been paid.

Example
10% debentures = $150,000
Full year’s interest = 10% × $150,000 = $15,000
Already paid = $5,000
Accrued = $15,000 − $5,000 = $10,000

Income statement

Finance cost = $15,000.

Statement of financial position

Other payables = $10,000.

This treatment is shown in the chapter’s full company example.

24. Year-End Adjustments

Limited companies make the same normal year-end adjustments as sole traders:

Closing inventory

Included before final profit.

Depreciation

Charged on non-current assets.

Accruals

Expenses owing are added.

Prepayments

Amounts paid early are adjusted.

Irrecoverable debts

Written off before final figures.

Provision for doubtful debts

Provision changes are included.

These must be included before final profit and equity figures are calculated.

Quick Comparison

Sole Trader	Partnership	Limited Company
One owner	Two or more partners	Shareholders
Capital account	Partners’ capital/current accounts	Share capital and reserves
Unlimited liability	Usually unlimited liability	Limited liability
No appropriation statement	Appropriation account	Statement of changes in equity
Owner manages	Partners manage	Directors manage

Key Terms

Limited company

Business owned by shareholders with limited liability.

Shareholder

Owner of one or more shares.

Limited liability

Shareholder’s risk is limited to their investment.

Unit of ownership or investment in a company.

Dividend

Part of company earnings distributed to shareholders.

Ordinary share

Main form of ownership share.

Preference share

Share normally receiving a fixed dividend before ordinary shares.

Retained earnings

Profits kept within the company.

General reserve

Profits transferred to a reserve for future needs.

Debenture

Long-term loan to a company.

Equity

Shareholders’ interest represented by share capital and reserves.

Remember

Company Finance
Shares = Ownership / Equity
Debentures = Loans / Liabilities

Ordinary vs Preference
Preference dividend first
Ordinary dividend afterwards

Debentures: interest must be paid → finance costShare capital: issued → shares issued; called-up → amount requested; paid-up → amount actually receivedEquity = Share Capital + Reserves