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O LevelAccountingCambridge (CIE)Revision Notes5. Preparation of Financial StatementsFinancial Statements for Limited CompaniesLimited Companies

Limited Companies (Cambridge (CIE) O Level Accounting)

Revision Note

Donna Simpson

Written by: Donna Simpson

Reviewed by: Dan Finlay

Limited Companies

What is a limited company?

  • A limited company is a business owned by a group of people

  • The ownership of the company is divided into parts known as shares

    • The people who buy the shares are known as the shareholders

    • Each share has a monetary value called nominal, face or par value

  • A limited company can be private (Ltd) or public (PLC)

    • Anyone can buy shares in a public limited company

    • Shares in a private limited company are not sold publicly

  • Owners of a limited company have limited liability

    • This means the business is a separate entity

    • The owners are only liable for the amount they invest

      • If the company goes bust then they only lose the amount invested

  • The reward the shareholder receives for investing their money in the limited company is called a dividend 

    • Dividends are paid from the profits the company makes 

    • Dividends are paid as a proportion of the face value of the shares owned by the shareholder

      • Dividend paid = number of shares × dividend per share

What are the advantages of operating as a limited company?

  • The owners of a limited company can usually generate more capital than sole traders or partnerships

  • The owners of a limited company have limited liability whereas sole traders and partnerships have unlimited liability

What are the disadvantages of operating as a limited company?

  • Limited companies come with more legal requirements than traders and partnerships such as audits and making financial statements public

  • It can cost more to set up a limited company than the costs of setting up a sole trader business or partnership

Capital Structure of Limited Companies

What are the types of shares?

  • The main types of shares are:

    • Ordinary shares

    • Preference shares

      • Redeemable preference shares

      • Non-redeemable preference shares

Ordinary shares

  • This is the main source of finance used by limited companies to fund their start-up or set-up

  • They are also known as equity shares

  • Ordinary shareholders are the owners of the company and they have voting rights

  • Ordinary shareholders receive dividends after preference shareholders are paid 

  • The dividend received by ordinary shareholders is not a fixed amount

    • Ordinary shareholders may have a high return on their investment if the company makes good profits during the financial year

    • The company may withhold paying dividends if their financial year was not as profitable as expected

  • The ordinary shares are shown as part of the equity section in the statement of financial position

  • The dividends paid for ordinary shares reduce the retained earnings and bank balance in the statement of financial position

    • These dividends do not affect the income statement

    • Dividends for ordinary shares are not accrued and only affect the financial statements when they are paid

Preference shares

  • Preference shares are given preference over ordinary shares

    • Their dividends are paid first

  • Preference shareholders do not have voting rights

  • Preference shareholders will receive a fixed rate of dividends based on the face value of the shares

  • The dividends are paid every year

Redeemable preference shares

  • The company can buy these shares back at a date and price to be agreed

  • Redeemable preference shares make it easier for the company to set a limit on how long they want to pay dividends these shareholders

  • The redeemable preference shares are shown as a non-current liability in the statement of financial position

  • The dividends paid for redeemable preference shares are included as a finance cost on the income statement

    • Any accrued dividends for redeemable preference shares are treated as a current liability on the statement of financial position

Non-redeemable preference shares

  • Non-redeemable preference shares are those which can not be bought back

  • The shareholders continuously receive dividends on their investment

  • Non-redeemable preference shares are shown in the equity section of the statement of financial position

  • The dividends for non-redeemable preference shares are included in the statement of changes in equity

    • These dividends do not affect the income statement

    • Dividends for non-redeemable preference shares only affect the financial statements when they are paid

Worked Example

What are the features of ordinary shares?

return received

rate of return

voting rights

A

dividend

based on profit

yes

B

dividend

fixed rate

no

C

interest

based on profit

yes

D

interest

fixed rate

no

Answer

A

This is the correct response as ordinary shareholders receive a return on their investment in the form of dividends paid to them which is based on the profits of the business.  Holders of ordinary shares are members and every share entitles the holder to a vote.

B

This refers to preference shareholders. Preference shareholders will receive a dividend as a return on the money invested, which will be paid from the profits of the business.  They are given preference in receiving their dividends before ordinary shareholders. However,  they do not have voting rights.

C

This is a trick answer and is not a correct response at all as it does not relate to ordinary shares, preference shares or debentures.

D

This is not correct as the response applies to debenture which is a form of loan.  Debenture holders will receive interest which is payable at a fixed rate. However, they do not have voting rights.

How is the capital of limited companies structured?

  • The capital structure consists of the following forms of equity

    • Equity is the total value of the company for the shareholders

Ordinary share capital

The money received by selling ordinary shares

Preference share capital

The money received by selling non-redeemable preference shares

General reserve

The money set aside for specific purposes such as an expansions or a contingency for potential losses

Retained earnings

The profits that are not distributed via dividends

What is the difference between share capital and loan capital?

  • Share capital is the amount raised by issuing shares of the company to shareholders

    • The amount of share capital that is issued to shareholders is known as the issued share capital 

    • The company might not ask for payment of the shares upfront

      • The amount that has been asked to be paid is known as the called-up capital

      • The amount that has been paid is known as the paid-up capital

  • Loan capital is the amount borrowed from external people

    • Debentures are long-term loans

      • The full amount is paid back at a specific date in the future

      • They carry a fixed rate of interest

      • Debentures are repaid before shareholders if the company goes bust

    • Redeemable preference shares are also treated as long-term loans

Worked Example

Which of the following statement is correct about debentures?

A

Debenture holders are allowed to vote at shareholders’ meetings.

B

Debentures are part of the equity of a limited company.

C

Debentures carry a fixed rate of interest.

D

Debentures carry a fixed rate of dividends.

Answer

A

Only ordinary shareholders are allowed to vote at shareholder’s meetings as they have voting rights.

B

Debenture is not part of the equity of the business as debenture is a form of long-term loan.

C

Debentures carry a fixed rate of interest. This is the correct answer.

D

Preference shares carry a fixed rate of dividend and not debentures.

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    Author
    Reviewer
    Donna Simpson

    Author: Donna Simpson

    Expertise: Accounting Content Creator

    Donna is a classroom practitioner with over 25 years experience in teaching accounting and business studies at GCSE A-Levels and undergraduate levels, both in the UK and abroad. She currently works for a Multi-Academy Trust (MAT) as a teacher, instructional coach and mentor to other teachers. Donna is also an AQA A Level Accounting examiner as well as the content creator of resources used by all accounting teachers across the Trust. She enjoys designing and creating resources that provides students with deeper understanding of the subject content. Donna has a Bachelor of Science Degree in Business Administration with major in Accounting and Finance (BSc Hons) and ACCA certified to Level 2.

    Dan Finlay

    Author: Dan Finlay

    Expertise: Maths Lead

    Dan graduated from the University of Oxford with a First class degree in mathematics. As well as teaching maths for over 8 years, Dan has marked a range of exams for Edexcel, tutored students and taught A Level Accounting. Dan has a keen interest in statistics and probability and their real-life applications.