Chapter 8 - Final accounts of company

A company is an organisation which is owned by shareholders but managed by a board of directors elected during an Annual General Meeting. A company is incorporated through the registrar of companies by submitting documents known as the memorandum of association and articles of association.

Advantages of incorporating a company

• Capital resources are available from more than one person
• Company has easier access to loan funds.
• Specialist and management skills can easily be brought into the business.
• Economies of scale may be enjoyed.
• The shareholders enjoy limited liability. Private property of the shareholders is not liable to settle the business obligations.
• Owners of the business can change without there being any effect on the business.

A company requires a large amount of capital. The total amount of capital is divided into number of smaller units (shares) of equal value. This pool as made up of shares is, therefore, called share capital. The main types of capital in a company are:

Authorised share capital

This is the maximum amount of share capital that a company can raise through the issue of shares. It is the maximum amount of share capital authorised by the registrar of companies. It is also known as registered or nominal share capital.

Issued share capital.

This is part of the authorised share capital which has been actually issued to the general public. It cannot exceed the authorised share capital. The amount of share capital that has not been issued is known as unissued share capital.

Called-up share capital.

Called-up capital is the amount that has not yet been completely paid, although payment has been requested by the company. It is part of the issued share capital which has been called for payments. The amount of share capital that has not been called yet is known as uncalled share capital.

Paid up share capital.

Any amount of money that has already been paid by investors in exchange for shares is paid-up capital. IN simple terms, it is the amount of share capital that has already been paid by the shareholders. The amount of called up share capital which has not been paid yet by investors is known as calls in arrears.

Types of shares:

• Preference shares.
• Ordinary shares.

Preference shares

Example:

Preference dividend               

=          Fixed % Rate × Preference Share Capital

=          12% × 125 000

=          $15 000

Characteristics of preference shares:

• Preference shareholders receive a fixed rate of dividend.
• They do not have voting rights during AGM.
• They receive dividend before ordinary shareholders.
• In case the company is wound up they receive their share of capital before ordinary shareholders.

Types of Preference shares:

Redeemable and non redeemable preference shares

Redeemable preference shares may be bought back by the company after maturity date. If an entity issues redeemable preference shares, then it must be recognised as a non current liability in the statement of financial position. Dividend paid on redeemable preference shares are disclosed as an expense in the income statement.

Ordinary shares

Calculation of ordinary dividend

Example 1

A company has the following ordinary share capital.

400 000 Ordinary shares of $0.60      $240 000

The directors paid an ordinary dividend of $ 0.10 per share.

Ordinary Dividend      

=          Rate * No of shares

=          0.10 * 400 000

=          $ 40 000

Example 2

A company has the following ordinary share capital.

700 000 Ordinary Shares of $ 0.80     $ 560 000

The directors paid an ordinary dividend of 10%.

Ordinary Dividend      

=          % Rate * OSC

=          10% * 560 000

=          $ 56 000

Characteristics of Ordinary shares:

• Ordinary shareholders receive a variable rate of dividend.
• They have voting rights during AGM.
• They are the last one to receive dividend.
• In case the company is closing down they receive their share of capital after preference shareholders.

Debentures

Debenture includes debenture stock, bonds and any other securities of a company. Debentures are long-term loan from general public carrying a fixed rate of interest and they do not have voting rights during an AGM. Debenture interest is paid before dividend is paid to preference and ordinary shareholders.

Example:

A company has the following:

15% Debentures of $1 each   $200 000

Finance cost (Interest on debentures)            

=          15% × 200 000

=          $30 000.

Reserves

There are two types of reserves:

• Revenue reserve
• Capital reserve

Revenue reserve

Revenue reserve arises from the normal trading activities of the company. Revenue reserve is created from the net profit generated from the company’s core operations. Revenue reserve can be used for payment of future dividend and to write off preliminary expenses.

Examples of revenue reserve:

• Retained earnings / profits
• General reserve

Capital reserve

This arises from changes in the capital structure of a company. A capital reserve is created out of capital profits and it cannot be used for payment of dividend. 

Examples of capital reserve:

• Share premium

Financial statements of a company 

The accounts prepared by limited companies for internal purposes are used by the managers for decision making. IAS 1 explains the way of presenting financial statements of a company. The standard entails that a company must prepare the following financial statements:

• Income statement (Statement of comprehensive income)
• Statement of changes in equity
• Statement of financial position

IAS rules for dividends

As per IAS 1 only dividends paid during the year are shown as deductions in the Statement of changes in equity. The proposed final dividend of current year needs shareholders’ approval at the Annual General Meeting and accordingly is not provided for in the financial statements and can only be disclosed by way of a note to the financial statements.

Worked example

Workings

1. Finance cost (Interest on debentures) = 10% * 50 000 = $ 5 000
2. Profit after interest = 53 000 – 5 000 = $48 000
3. Issue of shares = 20 000 * 0.70 = $ 14 000
4. Final dividend paid = [70 000 + 20 000] * $0.20 = $ 18 000

Question 1