Accounting Fundamentals: Chapter 11 - Company Financial statements

Legal status of a company

A company is separate from its owners: it can enter contracts, sue or be sued, and pays tax.

Types of companies

• Private (Ltd): Can’t sell shares to the public.

• Public (Plc): Can sell shares to the public, stricter rules.

2 Types of share values

• Nominal/par value: Fixed value of a share (e.g., £1). Doesn’t change.

• Issue price: Amount investors pay. Can be higher than nominal → excess = share premium.

Ordinary shares

• No fixed dividend

• Voting rights

• Treated as equity in the SOFP

Preference shares

• No voting rights

• Paid before ordinary shareholders

Redeemable preference

Treated as a liability, company must buy back eventually, dividend = fixed like interest.

Irredeemable preference

Treated as equity, no obligation to buy back, dividends may or may not be fixed.

Dividends journal for ordinary and I/R preference shares

• Ordinary/Irredeemable preference:
  Dr Retained earnings, Cr Accruals

• Redeemable preference:
  Dr Interest expense, Cr Accruals

Issuing shares journal (combined)

• Dr Cash (total received)

• Cr Share capital (nominal)

• Cr Share premium (excess)

Rights issue / Bonus issue

• Rights issue: Company offers existing shareholders new shares to raise cash

• Bonus issue: Free shares given to existing shareholders, company pays for using their reserves. No new cash is raised

Worked example (Bonus Issue):
Issue 2,000,000 £1 shares:
Dr Share premium £1,300,000
Dr Retained earnings £700,000
Cr Share capital £2,000,000

Retained earnings / other reserves

• Retained earnings = profits not distributed as dividends.

• Other reserves = part of retained earnings set aside for a specific reason.

Non-current liabilities Journal Entry for: Issue, Interest and repayment

• On issue: Dr Cash, Cr Liability

• Interest: Dr Interest expense, Cr Cash or Cr Accruals

• Repayment: Dr Liability, Cr Cash

Provisions definition + Journal entry

• Liability of uncertain timing/amount.

• Journal: Dr Expense, Cr Provision

• Example: Warranty: 10,000 units × 5% × £10 = £5,000 provision

Income tax Journal entry for: Estimate and payment

• Estimate: Dr Income tax expense, Cr Tax payable

• Payment: Dr Tax payable, Cr Cash

• Adjust next period for over/under provisions

Revenue recognition

• Recording income when it’s earned.

• Net of discounts, refunds, VAT

• Excludes: gains on asset disposal, interest & dividends

SPL categories (IFRS)

• Operating: Main business activities

• Investing: Dividends, interest, rentals

• Financing: Interest on debt, bank charges

Main company statements

• SOFP: Assets, liabilities, equity

• SPL: Revenue, expenses, profit/loss

• SoCE: Share capital, share premium, retained earnings, dividends

Number of shares formula

Total shares - Nominal value

Retained earning formula

Opening + Profit - Dividends + or - Transfers to other reserves

Accounting for share premium usage

Use share premium before retained earnings for bonus issues.

General exam tip – journals & adjustments

• Always double-check: debit = credit

• Include all adjustments affecting profit in retained earnings working

• For SPL adjustments: check expense category (wrong category may need two entries)