BUU22530: Introduction to Accounting - Topic 4: Business Organisations and Financing of Business

Course Overview

  • Course Title: BUU22530: Introduction to Accounting

  • Lecturer: Niamh Lynch ACA

  • Institution: Trinity College Dublin

  • Focus: Transforming Business for Good.

  • Accreditations: AACSB, AMBA, EFMD EQUIS

Learning Outcomes

Students should be able to:

  • Analyze different forms of business:

    • Advantages

    • Disadvantages

    • Financing options

  • Explain different sources of finance.

  • Discuss the returns from each source of finance.

  • Explain ordinary share capital and preference share capital.

  • Understand how cash is raised from an issue of shares.

  • Understand how bonus issues and rights issues work.

  • Discuss dividend distributions.

Types of Business Entities

Sole Trader

  • Definition: A simple format where a single owner manages the business.

  • Features:

    • Simple operations.

    • Solely responsible for business success.

    • Unlimited liability: personal assets can be claimed to cover business debts.

    • No legal formalities are required to start trading.

Partnership

  • Definition: A business format with two or more owners pooling resources.

  • Features:

    • All partners share management responsibilities.

    • Profits or losses are shared among partners.

    • Unlimited joint and several liability for debts incurred.

    • Written agreement preferable but not mandatory to start trading.

Limited Companies

Types

  1. Private Limited Company (Ltd)

    • Characteristics:

    • Shares cannot be sold to the public.

    • Generally has fewer shareholders.

    • Designated by the word “Limited” or “Ltd.”

  2. Public Limited Company (PLC)

    • Characteristics:

    • Sells shares to the public.

    • Has many shareholders and shares are traded on recognized stock exchanges.

    • Designated by the term “PLC.”

    • Governed by the Companies Act 2014 and corporate governance codes.

Characteristics of Limited Liability Companies

  1. Separate Legal Identity

    • Operates independently of its owners.

    • Can sue and be sued in its own name.

  2. Share Capital

    • Funds raised through issuance of shares.

  3. Limited Liability for Shareholders

    • Liability limited to the amount unpaid on shares.

    • Shareholders lose only the capital invested if the company fails.

  4. Governance Structure

    • Managed by directors elected by shareholders at the Annual General Meeting (AGM).

  5. Annual Reporting

    • Annual accounts and reports are prepared and presented at the AGM.

  6. Formation Documents

    • Registered with the Registrar of Companies; includes the Memorandum and Articles of Association.

Audit and Reporting Obligations

Auditor

  • Responsible for verifying financial statements and ensuring they comply with laws and regulations.

Annual Accounts

  • Statutory requirement under the Companies Act 2014 (Ireland) and Companies Act 2006 (UK).

  • Shared with shareholders and lodged for public reference.

Financing Business

  • Essential for:

    • Starting a business.

    • Expansion and operations.

  • Providers of finance expect rewards (returns) for their investment in the business.

Types of Business Finance

1. Short-term Finance

  • Definition: Immediate funding solutions.

  • Example: Bank overdraft.

    • Repayable immediately; non-contractual agreement; varying monthly limits imposed by the bank.

2. Medium-term Finance

  • Definition: Finance with a fixed amount and fixed term.

  • Example: Bank loan.

    • Regular payments, including interest and capital.

    • Stronger contractual obligation compared to short-term finance.

3. Long-term Finance

  • Definition: Extended financing options typically issued by limited companies.

  • Sources:

    • Ordinary and preference share capital.

    • Issued to raise substantial cash for business activities.

    • Dividends paid to shareholders; unlike interest, dividends are not mandatory.

Share Capital

Ordinary Share Capital

  • Advantages:

    • High potential dividends.

    • Value appreciation of shares.

    • Voting rights in company meetings.

  • Limitations:

    • High risk; dividends may not be paid.

    • Potential loss of investment in case of liquidation.

Preference Share Capital

  • Definition: Provides preferential treatment for specific shares.

  • Dividend Payments: Preference shareholders receive dividends prior to ordinary shareholders.

  • Restrictions:

    • Fixed dividend rate; no further rights beyond stipulated dividends.

    • No voting rights.

    • Rights limited based on the risk profile compared to ordinary shares.

Share Issues

At Par Value

  • Definition: Shares issued at face value (e.g., €1, €0.50).

  • Accounting Treatment:

    • Shareholders pay cash for shares which increases cash assets and share capital in the statement of financial position (SOFP).

    • Example question regarding share issue at par value.

At a Premium

  • Definition: Shares sold above their par value.

  • Importance:

    • Protects existing shareholders from dilution and reflects the value increase of the company.

  • Example of Premium Accounting Treatment: Share issued at a premium raises additional cash beyond par value.

Bonus Issues

  • Definition: Shares distributed to existing shareholders without raising cash.

  • Purpose:

    • Increases shareholder equity, offers a psychological boost to investors, and may improve market confidence.

  • Accounting Treatment: Due to the conversion of retained earnings into share capital.

Rights Issues

  • Definition: Offering existing shareholders the opportunity to purchase new shares generally at a discount to the current market price.

  • Pre-emption Rights:

    • Protects against dilution of existing shares. Important legally and ethically.

  • Pricing: Typically less than current market price to encourage uptake of rights.

Dividend Distribution

  • Definition: Payment made out of profits to shareholders based on shares held.

  • Legal Aspects:

    • Not classified as an expense of the company; deducted from retained earnings of the SOFP.

    • Companies may declare interim and final dividends.

  • Legality: Dividends can only be paid from distributable reserves.

Conditions for Paying Dividends

  • Dependent on financial resources and future commitments, not legally obligatory.

Example Calculations

  • Evaluation of share issuance questions involving net assets and cash generation.

Required Readings

  • Chapter 5, Scott textbook