Welcome to Limited Company Accounts!
Hello there! Ready to dive into the world of big business? So far, you might have looked at sole traders or partnerships. Moving into Limited Companies is a big step, but it’s an exciting one! Companies like Apple, Tesco, or even your local "Ltd" garage operate under different rules because they are "legal people" separate from their owners. In this chapter, we will learn how to record their profits, how they handle their "Equity," and what they have to tell the public.
Don't worry if this seems tricky at first! We are basically just adding a few more "drawers" to the filing cabinet of accounting you’ve already started building.
1. The Three Big Statements
For your exam, you need to know how to prepare and understand the internal financial statements for a company. These are:
1. The Income Statement (How much we made)
2. The Statement of Changes in Equity (The link between profit and the owners)
3. The Statement of Financial Position (What we own and owe)
The Income Statement: Three Levels of Profit
In a sole trader account, you usually just find "Net Profit." In a limited company, we need to be more specific because companies pay interest on loans and Corporation Tax to the government. You must show the distinction between:
• Profit from operations: This is the profit made from the actual business activities, before paying interest or tax.
• Profit for the year before tax: This is Profit from operations minus finance costs (interest).
• Profit for the year after tax: This is what is left after the government takes its slice (tax).
Example: If a company makes £100,000 selling shoes, pays £5,000 in loan interest, and £18,000 in tax, the "Profit for the year after tax" is £77,000.
The Statement of Financial Position (SOFP)
This is very similar to a sole trader's balance sheet, but the "bottom half" looks different. Instead of "Capital," we use the heading Equity. The main sub-headings you need are:
• Non-current assets: Long-term stuff like vans and machinery.
• Current assets: Short-term stuff like inventory and cash.
• Equity: The owners' claim (Share Capital, Share Premium, and Retained Earnings).
• Non-current liabilities: Long-term debts like Debentures (loans).
• Current liabilities: Short-term debts like trade payables or tax owed.
Quick Review: Remember the basic accounting equation? \(Assets - Liabilities = Equity\). It still works exactly the same way here!
2. The Statement of Changes in Equity (SOCE)
This is a new table for many students. Think of it as a "bridge" that explains why the Equity section of the balance sheet moved from its starting value to its ending value.
Common entries in the SOCE:
• Opening balances: What we started with on day one.
• Profit (or Loss) for the year: Profit makes equity go UP!
• Dividends paid: When the company gives cash back to shareholders, equity goes DOWN.
• Issue of shares: If we sell new shares at a premium (more than their face value), equity goes UP.
• Closing balances: The final totals that go onto the SOFP.
Did you know? Dividends are not an expense. They don't go in the Income Statement. They are a distribution of profit, so they only appear in the SOCE!
3. Issuing Shares: Rights vs. Bonus Issues
Sometimes a company needs more cash, or it wants to reward its owners. There are two specific ways they do this that you must know:
Rights Issue
This is when a company offers existing shareholders the chance to buy more shares, usually at a price lower than the current market price.
• Why? To raise cash for the business.
• Effect: Bank goes up, Share Capital goes up, and Share Premium usually goes up.
Bonus Issue
This is like a "gift." The company gives free shares to existing shareholders by turning some of its reserves (like Retained Earnings) into Share Capital.
• Why? To make the company look more stable or to reward shareholders without spending cash.
• Effect: Share Capital goes up, but Retained Earnings go down. No cash changes hands!
Analogy: A Rights Issue is like a shop offering you a "VIP discount" to buy more goods. A Bonus Issue is like the shop giving you a "Buy One Get One Free" voucher using the credit you already had on your loyalty card.
4. Advanced Adjustments (IAS 1 and IAS 7)
AQA wants you to follow International Accounting Standards (IAS). Don't let the fancy names scare you; they are just sets of rules to make sure everyone does accounting the same way.
Revaluation of Non-Current Assets
Sometimes, an asset like land becomes worth much more than what you paid for it. Under IAS rules, you can revalue it.
• The Entry: Increase the value of the asset and create a Revaluation Surplus (which is part of Equity).
• Key Point: This isn't "profit" you can spend yet; it's just an increase in the value of what you own.
Statements of Cash Flow (IAS 7)
Profit is great, but you can't pay workers with "profit"—you need cash! The Statement of Cash Flow shows where the cash actually came from and where it went. For your syllabus, you focus on the indirect method.
The indirect method starts with Profit and adjusts it for things that aren't cash. For example:
• Depreciation: It's an expense that lowers profit, but no cash actually leaves the bank. So, we add it back!
• Inventory: If inventory goes up, it means we spent cash to buy it. So, we subtract the increase.
Memory Aid: "A-I-D" (Add Increases in Depreciation/Liabilities, Deduct Increases in Assets). If a current asset goes up, cash goes down!
5. Why Publish Accounts?
Limited companies (especially Public Limited Companies/PLCs) are required by law (The Companies Act) and accounting standards (IAS1) to publish their accounts. But why?
• Accountability: Managers need to show the owners (shareholders) how they used their money.
• Stakeholders: People like the bank (to check if they'll get their loans back), the government (for tax), and employees (for job security) all want to see the performance.
• Comparability: By following the same rules (IAS), investors can compare Tesco's performance against Sainsbury's easily.
Common Mistake to Avoid: Don't confuse "Internal" accounts with "Published" accounts. Internal accounts are detailed for managers. Published accounts are more summarized for the public.
Summary: Key Takeaways
• Limited Companies have separate legal identities and use Equity instead of "Owner's Capital."
• Profit is shown at three levels: Operations, Before Tax, and After Tax.
• The SOCE tracks the movement of Share Capital, Premiums, and Retained Earnings.
• Rights Issues bring in cash; Bonus Issues do not.
• IAS 1 and IAS 7 provide the rules for how these statements should look and how to handle cash flow.
• Revaluing an asset increases its value on the SOFP and creates a reserve in Equity.
You've got this! Company accounts are just about following the map. Once you know where the items go, the rest is just simple math.