Chapter 13 - Company Financial Statements And Associated Matters

Question 1

What is meant my limited liability?

Answer 1

• shareholders only liable for any amounts outstanding on the shares they hold

Question 2

What are the 3 main differences between the financial statements of a company and those of a sole trader

Answer 2

• the way in which profit is dealt with
• the composition of capital on the balance sheet
• the statutory requirements

Question 3

Describe the differences in taxation of a sole trader and that of a company

Answer 3

• sole trader pays tax on their adjusted profits, sole trader taxed personally as is liable to income tax
• tax is personal to the sole trader and will not appear on the accounts
• company will pay tax on its profits
• shown as a deduction from the profit available to owners and shareholders

Question 4

What is corporation tax and when is it payable?

Answer 4

• provision for the tax based on the profits from the year
• does not represent tax paid because corporation tax is not payable immediately
• instead it is due 9 months after the year end or for large companies by instalments

Question 5

What are the double entries for a corporation tax charge

Answer 5

Corporation tax charge debit (profit and loss) - reduces income
Corporation tax creditor credit (b/s liability)

During year when the tax is paid
Corporation tax creditor debited (liability reduced)
Bank a/c credited (reduction in asset/cash)

Question 6

What are dividends?

Answer 6

• payments to the shareholders and are paid after all other expenses have been deducted

Question 7

Where are dividends recorded?

Answer 7

• deducted from accumulated profit/loss on company’s b/s as the profit and loss reserve account or retained earnings

Question 8

What as an interim dividend?

Answer 8

• an amount paid on account of the total dividend before the end of the year

Question 9

What is the double entry for an interim dividend?

Answer 9

Profit and loss account reserve debited (b/s) (increase in drawings/expenses)
Bank credited (reduction in assets)

Question 10

Describe fixed assets on a company’s b/s

Answer 10

• would normally only show NBV on face of the b/s with details of cost and provision for depreciation being provided by way of a note
• same follows for breakdown of its debtors and creditors

Question 11

What are the advantages of a company compared with a sole trade?

Answer 11

• if company goes into liquidation owners of the company only liable to pay any amounts that they have not yet paid for the shares they hold
• a sole trader would be personally liable for all outstanding debts
• shareholders can share in the profits of the business without necessarily having work for the business
• companies are in a better position when borrowing money
• a company will continue to exist even if the shareholders die
• if sole trader de the business will only continue if sold

Question 12

What are the disadvantages of a company compared with a sole trade

Answer 12

• most companies require an audit of their financial statements and therefore must pay auditors fees unless the company is small and exempt from this requirement
• company must prepare its financial statements in a format prescribed by regulations
• company suffers a greater admin burden than a sole trader

Question 13

What is the double entry for the issue of shares?

Answer 13

Bank a/c debited (increase in cash/assets)
Share capital a/c credited (increase in liabilities)

Question 14

When does a share premium account arise

Answer 14

When a company issued shares at a premium over the nominal or par value of those shares

Question 15

What does the profit and loss reserve account in the b/s represent?

Answer 15

• cumulative profits less losses ever made by the company less any amounts paid out by the company to the shareholders as dividends
• same idea as adding profits of sole trader to capital a/c

Question 16

What is the double entry at the end of the accounting period to transfer the profit for the year to the reserves?

Answer 16

Profit and loss a/c debited (income statement)
Profit and loss reserve a/c credited (b/s)

Question 17

What is shareholders finds?

Answer 17

• Total of share capital and reserves
• directly comparable with proprietors funds

Question 18

How can a company raise finances?

Answer 18

• issuing shares
• loans

Note: sole trader is unable to raise finance via shares

Question 19

What is the principal reason for a company to make a bonus share?

Answer 19

• bonus issue reduces the market value of each share increasing its attractiveness to investors

Question 20

What is a bonus share?

Answer 20

• extra shares issued to existing shareholders without any money having to be paid

Question 21

What is the double entry for a bonus issue of shares?

Answer 21

Profit and loss reserve a/c debited
Ordinary share capital credited

Question 22

What is the rights issue of shares?

Answer 22

• shares issued at a favourable price e to the existing shareholders

Question 23

What 3 options does a shareholder who receives a rights offer have?

Answer 23

• take up the rights and pay the required amount to the company increasing their shareholding
• sell their rights to a third party who may then subscribe for the shares from the company
• do nothing and let their rights lapse

Question 24

What happens if shareholder lets their rights lapse?

Answer 24

• company will sell the rights and send them the proceeds

Question 25

Companies unlike a sole trader are able to issue a capital instrument in order to raise finance. What are the usual financial instruments and how are these recorded?

Answer 25

- debentures, loans and debt instruments - forms of creditors and are disclosed on the b/s

Question 26

What are debentures?

Answer 26

- most common form of loan finance obtained by larger companies - loans repayable at a fixed date at some point in the future - usually a fixed amount of interest that is due - usually LT creditor - lower interest than other loans

Question 27

What are the double entries for financial instruments?

Answer 27

Bank debited (increase in cash) Long term creditor credited (increase in liabilities) When loan is received by the company Interest paid debited (increase in expenses) Bank credited (decrease in cash) With the annual interest paid to the providers of the loan finance

Question 28

What is a directors loan a/c?

Answer 28

- similar to the partners’ current account - director can draw cash out the business as and when it is needed

Question 29

What is the double entry for a withdrawal from a directors loan a/c?

Answer 29

Directors loan a/c debited (increase in drawings) Bank a/c credited (decrease in cash)

Question 30

At the end of the year the director will vote themselves salary and bonuses. Rather than there being paid to the director they will go through the loan account. What is the double entry?

Answer 30

Salaries debited (p&l expense) Directors loan a/c credited (b/s creditor)