ACCOUNTING FOR COMPANIES

BFS 1202: ACCOUNTING IN BUSINESS II

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Intended Learning Outcomes

– Understand the capital structure of a company.

– Compare and contrast a Company and other forms of
business.
– Prepare financial statements for a limited liability
company and understand the true and fair view
requirements.
– Understand the nature of reserves.
– Understand issue of share capital.

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Introduction

• A company is a form of business formed by a group people

called the promoters.
• Once formed, the law recognizes the company as a legal person
separate from the owners by all means.
• This means that it can sue or be sued in its own name; it can
borrow funds in its own name or even enter into contract in its
own name.
• This concept is sometimes referred to as the veil of incorporation.

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• A company is greater in size and complexity than either the sole
proprietorship or the partnership
• It’s also a more recent form of business. It actually came into
existence after the partnership in an effort to cover the shortfalls
of a partnership form of business.

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Factors Distinguishing Companies

• Separate legal entity concept:

• the company is a separate entity in law
• Separation of the ownership:
• (shareholders) from the management (directors) of the company
• Limited liability of shareholders for the debts of a company.
• Generally speaking, their liability will be limited to any portion of
the nominal value of shares which is unpaid.
• Formalities required.
• These vary from country to country but frequently require public
availability of financial statements and annual audit by qualified
auditors.

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Types of Limited Liability Company
• Public Limited Company
• The company can offer its shares to the public and its shares which are
traded on the securities exchange.
• The company name must end with "public limited company“ or “plc.”
• They can invite the members of the public to invest in their ownership
• Private Limited Company
• The company may only offer shares to business associates, friends and
family.
• Being private, they cannot invite the members of the public to invest in their
ownership.
• Shares will not be traded on the securities exchange. The company name
will end with "limited" or “ltd”

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Regulatory Framework for Listed
Companies
• The listed companies are regulated by Kenya Companies Act of
2015.
• The Act guides listed companies in the preparation and
publication of final accounts.
• Kenya Companies Act sets out the general framework for
accounting and reporting by all the listed companies and
stipulates the minimum requirements with regard to financial
reporting.
.

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• The Company Act requires all the listed companies to prepare
proper books of account that give a true and fair view of the state
of company affairs and transactions
• The Act requires annual financial statements to contain profit and
loss account, balance sheet, statement of cash flow, statement of
changes in equity, directors report, and auditors report in line
with the prescribed accounting standard.

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Continuation…
• Kenya adopted International Financial Reporting Standards (IFRS)
from the International Accounting Standards Board (IASB) in 1999 to
enhance transparency and uniformity in corporate reporting.
• All public companies’ shares are traded on the Securities Exchange
(NSE).
• NSE offers a world class trading facility for local and international
investors looking to gain exposure to Kenya and Africa’s economic
growth.
• NSE is playing a vital role in the growth of Kenya’s economy by
encouraging savings and investment, as well as helping local and
international companies access cost-effective capital.

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Continuation…

• The ones that are traded are known as ‘listed companies’ meaning
that their shares have prices quoted (i.e. quoted shares) on the
NSE
• They have to comply with Nairobi Securities Exchange
requirement.
• NSE operates under the jurisdiction of the Capital Markets
Authority of Kenya.

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• The Capital Markets Authority is the Government Regulator
charged with licensing and regulating the capital markets in
Kenya.
• It also approves public offers and listings of securities traded at
the Nairobi Securities Exchange.

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Means of funding/sources of finance

• Share Capital
• Loan stock and bonds
• Reserves

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i. Share Capital

• To become an owner of any company a person must have

contributed to its capital.
• To facilitate this the total capital required by the company is
divided into small units or shares.
• One becomes a member of a company (shareholder) by
purchasing one or more of the shares.
• Share capital is thus the capital raised from members of the
company.
• As expected shareholders expect return on their capital/investment.

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Types of Share Capital

• The share capital is the capital of a company which is divided

into preference and ordinary shares which are then bought and
owned by the shareholders.
• There are two main types of share capital
1. Preference Shares
2. Ordinary Shares

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a) Preference Shares

• Preference shares are shares which confer certain preferential

rights on their holder.
• They usually do not have voting rights
• Preference shares are entitled to a fixed percentage of dividends
before any ordinary dividends are paid
• receive their dividends of profit before the ordinary share
dividend (higher priority).
• receive capital before ordinary shareholders in the event the
company is closed down.

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Classification of preferences

• Preference shares may be classified in one of two ways.

– Redeemable
– Irredeemable

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i. Redeemable preference shares

• Mean that the company will redeem (repay) the nominal value of
those shares at a later date.
• For example, 'redeemable 5% $1 preference shares 20X9' means
that the company will pay these shareholders $1 for every share
they hold on a certain date in 20X9.
• The shares will then be cancelled and no further dividends paid.
• Redeemable preference shares are treated like loans and are
included as non-current liabilities in the statement of financial
position.

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ii. Irredeemable preference shares

• Irredeemable preference shares are treated just like other

shares. They form part of equity and their dividends are treated as
appropriations of profit.

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b) Ordinary shares

• Ordinary shares are by far the most common type of shares.

• They carry no right to a fixed dividend but are entitled to all profits
left after payment of any preference dividend.
• Generally, however, only a part of such remaining profits is
distributed, the rest being kept in reserve.
• Ordinary shares are shares which are not preferred with regard
to dividend payments.
• Thus a holder only receives a dividend after fixed dividends have
been paid to preference shareholders

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• The dividends of ordinary shares are not fixed.
• They depend on the return of the company
• Ordinary shareholders are paid only after all other claim (e.g.
loan interest and preference share dividends) have been met
• Ordinary shareholders usually have voting rights

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ii. Loans stock and bonds

• Limited liability companies may issue loan stock or bonds. These

are long-term liabilities.
• In some countries they are described as loan capital because they
are a means of raising finance, in the same way as issuing share
capital raises finance.

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Difference between share capital and loan
capital

• Shareholders are members of a company, while providers of

loan capital are creditors.
• Shareholders receive dividends (appropriations of profit)
whereas the holders of loan capital are entitled to a fixed rate of
interest (an expense charged against revenue).
• Loan capital holders can take legal action against a company if
their interest is not paid when due, whereas shareholders cannot
enforce the payment of dividends.
• Loan stock is often secured on company assets, whereas shares
are not.

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Continuation…

• The holder of loan capital is generally in a less risky position

than the shareholder.
• They have greater security, although their income is fixed and
cannot grow, unlike ordinary dividends.
• As remarked earlier, preference shares are in practice very
similar to loan capital, not least because the preference dividend
is normally fixed.

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iii. Reserves

• Reserves are profits or gains which accrue to ordinary

shareholders
• They are undistributed profits which have been retained within
the company
• There are two types of reserves:
– Revenue reserves
– Capital reserves

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Revenue reserves

• They are undistributed trading profits

• They can be used to pay dividends
• E.g. the balance on the profit and loss account and general
reserve

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Capital reserves

• They are gains or profits arising from non-trading or non-

operating activities
• They are not available for distribution as dividends
• E.g. Share premium, revaluation reserve, capital redemption
reserve and debenture redemption reserve

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Share premium

• When a company issues shares at a price above par, the excess

amount is called share premium
• The reserve is restricted to be used in the following ways:
– To write off preliminary expenses
– To write off expenses of issuing shares
– To write off commission paid and discounts on shares
– To pay up a bonus issue
– To provide premium on redemption of debentures

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Revaluation reserve

• This is the unrealized gain from an increase in the value of an

asset after revaluation.

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Capital redemption reserve and
Debenture redemption reserve

• This arises as a result of a company redeeming its shares or loan

bonds/debentures by using its retained profits

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Capital Structure

• Authorized (or legal) capital is the maximum amount of share

capital that a company is empowered to issue. The amount of
authorized share capital varies from company to company, and
can change by agreement.
• Issued capital is the par amount of share capital that has been
issued to shareholders.
• The amount of issued capital cannot exceed the amount of
authorized capital.

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Capital Structure

• Called-up capital. When shares are issued or allotted, a

company does not always expect to be paid the full amount for
the shares at once. It might instead call up only a part of the issue
price, and wait until a later time before it calls up the remainder.
• Paid-up capital. Like everyone else, investors are not always
prompt or reliable payers. When capital is called up, some
shareholders might delay their payment (or even default on
payment). Paid-up capital is the amount of called-up capital that
has been paid.

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Presentation of financial statements

• IAS 1 lists the required contents of a company's financial

statements. It also gives guidance on how items should be
presented in the financial statements.
• A complete set of financial statements includes a statement of
financial position, a statement of profit or loss and other
comprehensive income, a statement of changes in equity, a
statement of cash flows and disclosure notes.

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IAS 1 Presentation of financial statements

• A complete set of financial statements includes the following.

– Statement of financial position
– Statement of profit or loss and other comprehensive income (either
as a single statement or as two separate statements: the statement of
profit or loss and the statement of other comprehensive income)
– Statement of changes in equity
– Statement of cash flows
– Notes, including a summary of significant accounting policies and
other explanatory information

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Ledger accounts and limited liability
companies

• Limited companies keep ledger accounts.

• The only difference between the ledger accounts of companies
and sole traders is the nature of some of the transactions, assets
and liabilities for which accounts need to be kept.
• For example, there will be an account for each of the following
items.

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a) Taxation

• Tax charged against profits will be accounted for by:

Dr. I/S (income statement)
Cr. Taxation payable account
• The outstanding balance on the taxation payable account will be a
liability in the statement of financial position, until eventually
paid, when the accounting entry would be:
Dr. Taxation payable account
Cr. Cash account

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b) Dividends

• A separate account will be kept for the dividends for each

different class of shares (e.g. unredeemable preference, ordinary).
• When dividends are paid, we have:
Dr. Dividends paid account
Cr. Cash

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Loan stock

• Loan stock being a long-term liability will be shown as a credit

balance in a loan stock account.
• Interest payable on such loans is not credited to the loan account,
but is credited to a separate payables account for interest until it
is eventually paid: i.e.
Dr. Interest account (an expense, chargeable against profits)
Cr. Interest payable (a current liability until eventually paid )

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Share capital and reserves

• There will be a separate account for:

– Each different class of share capital (always a credit balance b/d)
– Each different type of reserve (always a credit balance b/d)

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Finance costs

• Finance costs mean interest paid.

• They include interest on bank loans, the loan stock interest and
the dividend paid on redeemable preference shares.
• The entries are exactly the same.
Dr. Interest account (an expense, chargeable against profits)
Cr. Interest payable (a current liability until eventually paid)

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Statement of profit or loss and other comprehensive income

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Statement of changes in equity

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 XX Ltd. Company
Statement of financial position as at 31 Dec XXXX
Non-current Assets Cost Dep Net
Machinery X X X
Furniture X X X
X X X
Current Assets
Stock X
Debtors X
Bank X X
TOTAL ASSETS XX

Financed by:
Share Capital Authorized Issued

XXXX Ordinary Shares of $1 each X X X

XXXX 8%Preference Shares of $1 each X X X

Share Premium X
General Reserve X
X
Retained profit c/d X

Long-term Liabilities
10% Debentures X X

Current Liabilities
Creditors X
Debenture interest accrued X
Provision for taxation X X
TOTAL EQUITY & LIABILITIES XX

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IAS 1 minimum requirements

• As a minimum, IAS 1 requires the following items to be

disclosed on the face of the statement of profit or loss and other
comprehensive income.
Revenue
• There are important rules on revenue recognition and these are
the subject of IFRS 15 Revenue recognition.

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IAS 1 minimum requirements

Cost of sales
This represents the summary of the detailed workings we have used
in a sole trader's financial statements.
Opening stock X
Purchases X
Less, closing stock (X)
XX
Expenses
Notice that expenses are gathered under a number of headings. Any
detail needed will be given in the notes to the financial statements.

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IAS 1 minimum requirements

Managers' salaries
• The salary of a sole trader or a partner in a partnership is not a
charge to the statement of profit or loss but is an appropriation of
profit.
• The salary of a manager or member of management board of
a limited liability company, however, is an expense in the
statement of profit or loss, even when the manager is a
shareholder in the company.
• Management salaries are included in administrative expenses.

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IAS 1 minimum requirements

Finance cost
• This is interest payable during the period. Remember (from the
previous slides) that this may include accruals for interest
payable on loan stock.

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Taxation

• Taxation affects both the statement of financial position and the

statement of profit or loss.
• All companies pay some kind of corporate taxation on the profits
they earn, which we will call income tax in line with the
terminology in IAS 1, but which you may find called 'corporation
tax'.

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• The rate of income tax will vary from country to country. There
may be variations in rate within individual countries for different
types or size of company
• Note that because a company has a separate legal personality,
its tax is included in its accounts

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Treatment for taxation

a) The charge for income tax on profits for the year is shown as
a deduction from profit for the year.
b) In the statements of financial position, tax payable to the
Government is generally shown as a current liability, as it is
usually due within 12 months of the year end.

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Gains on property revaluation

• Gains on property revaluation arise when a property is revalued.

• The revaluation is recognized in the other comprehensive
income part of the statement of profit or loss and other
comprehensive income and shown in the statement of changes in
equity as a movement in the revaluation surplus.

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