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Advanced Financial Accounting

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Advance Financial Accounting (FIN-611)
VU
LESSON # 20
COMPANY ACCOUNTS
How a company differs from other organizations? This is the question that will make
able the students/readers to understand company accounts. In the upcoming section
of this chapter emphasis will be put on the points of difference form accounting
perspective.
Company style of business entity is a bigger setup comparing with the sole
proprietorship and partnership. People with business ideas join their hands with
people having money. Jointly they form a business in which the investors (normally)
do no take interest in the day to day management affairs.
Salient Features of Limited Liability Companies
Following are the salient features that make a limited liability company different from
other business entities.
1) Separate legal entity
Unlike sole proprietorship and Partnership organizations the Company style of
business is an incorporated organization that enjoys a separate legal entity. It means
that from the legal point of view company and owners of the company are two
different persons.
This concept is often confused with the "Business entity concept" which is merely an
accounting concept and is used to record financial information of an entity. Whereas,
"Separate legal entity" signifies that a company has a legal status and it can sue and
can be sued in its own name.
2) Limited liabilities
Owners of a Company style of business enjoy an advantage that if a company runs
into financial difficulties, they cannot be forced to make further contributions to the
company. Even they are not asked to make good any financial losses suffered by the
company.
Liabilities of the owners of a company are limited to the amount of paid up share
capital (amount contributed by them). Maximum risk exposed to an owner of a
company is the loss of contributed capital money.
3) Board of directors
Management affairs of a company are run by a board of directors that is elected or
appointed by the owners. The board of directors runs the company on behalf of its
owners, in a way it can be said that directors act like stewards.
Directors are responsible for decision making, for running day to day business affairs,
for managing financial issues.
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Advance Financial Accounting (FIN-611)
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4) Sources of finance
Like other business organizations a company also gets its finances from owners and
lenders but the circle of its owners and lenders is very large.
5) Capital from owners
At the time of its incorporation the company makes an estimate of the total amount of
capital that will be required in the business. This capital is split into shares and hence
is known as share capital. People (investors) who want to become owner of the
company contribute in the share capital. Contributors of the share capital are known
as share holders or members of the company. A limited liability company is jointly
owned by its members.
6) Borrowings from lenders
Large business projects are undertaken by the company style of business which need
huge amount of finance. Such financial requirements are often cannot be met with the
contributed share capital alone. For this purpose a company borrows finances from the
financial institutions (like Banks etc.) and also a company can borrow from public in
general by issuing loan/debenture certificates. Holders of these certificates are known
as debenture holders.
7) Legal formalities
Company style of business entity undertakes huge ventures that involve contracts
with suppliers, customers, lender and so many other concerns. Also it has large
number of share holders. This might create certain difficulties to the management and
to the related parties as well. Therefore incorporation of Limited Liability Company
requires certain legal formalities and is tied up in more tight regulations to run the
entity, which are not required to be abided by the sole proprietorship and partnership
style of business entities.
8) Reporting requirements
As a limited liabilities company is involved in transactions with a huge number of
stake holders, therefore its directors are required to publish and circulate financial
statements with regular intervals which may be a quarter, six months or a year,
depending upon the nature of the company.
Finances of a Limited Liability Company
A company gathers its finances from two sources:
1. Owned Equity
2. Borrowed Equity
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Advance Financial Accounting (FIN-611)
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1) Owned Equity
Owned equity comprises of:
a) Equity share capital (contributed by the member)
b) Reserves (realized/unrealized profits)
i.
Capital Reserves
Share premium (unrealized profit)
Revaluation reserve (unrealized profit)
Capital redemption reserve (realized profit)
ii.
Revenue Reserves
Retained/Accumulated profits (realized profits)
General reserves (realized profits)
Named/Specific reserves (realized profits)
o Plant replacement reserve
o Dividend equalization reserve
All of the categories mentioned above will be discussed in details along with
accounting entries in the forthcoming part of this chapter. Following table will help in
understanding the difference between equities of different entities and how owners
are differently identified.
Sole
Partnership
Company
proprietorship
Owners' Equity
Capital
Capital Account  Share Capital
+ Net profit
+ Current Account Reserves
- Drawings
Proprietor
Partner
Member
Owners
2) Borrowed Equity
Borrowed equity comprises of:
a) Borrowings as Loan from the financial institutions
b) Borrowings as Debt certificates issued to the financers/lenders
Accounting for Share Capital and Reserves
Keeping in view the rules of Dr and Cr for the items of owners' equity, (increase Cr.
and decrease Dr.) the accounting entries for the transactions relating to the movement
in owners' equity are as under:
Accounting for issue of Share Capital
For issue of share capital at nominal value (at par) against cash consideration:
Bank a/c
Share Capital a/c
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Advance Financial Accounting (FIN-611)
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For issue of share capital at nominal value (at par) against non cash consideration:
Assets a/c
(like fixed assets or stock)
Share Capital a/c
For issue of share capital at a premium
Bank a/c
Share Capital a/c
Share Premium a/c
Share premium
Companies having strong background often issue their shares at a price that is more
than the nominal (face) value. Excess of the issue price over the nominal value is
known as share premium.
Note: Remember one very important tip; share capital a/c always credits with its
nominal (face) value only, any excess received as resources will be credited to the
share premium a/c.
Solved problem:
Rafi Ltd Co issues 100,000 ordinary share capital @ Rs 10 each with a premium @ Rs 7
per share.
Record the above transaction in the books of accounts.
Working:
RS.
100,000 @ Rs. 10
1,000,000
100,000 @ Rs. 7
700,000
1,700,000
Accounting Entry:
Bank a/c
1,700,000
Share Capital a/c
1,000,000
Share Premium a/c
700,000
Ledger Accounts:
Share Capital a/c
Rupees
Rupees
Bank a/c
1,000,000
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Advance Financial Accounting (FIN-611)
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Share Premium a/c
Rupees
Rupees
Bank a/c
700,000
Bank a/c
Rupees
Rupees
Share Capital a/c
1,000,000
Share Premium a/c
700,000
Accounting for movements in Reserves
Reserves are profits that are retained in the company (not distributed to its
shareholders). To understand the accounting entries for movement in Reserves
following details will be very much helpful.
Reserves
Capital Reserves
Revenue Reserves
Those profits which are not distributed Those which are distributable to share-
To the share holders as cash dividend
holders as cash dividend.
Share
Capital
General
Retained
Premium
Redemption
Reserve
Profits
Reserve
Revaluation
Named/Specific
Reserve
Reserve
Plant
Dividend
Replacement
Equalization
Reserve
Reserve
Profits
Un-Realized Profits
Realized Profits
Share Premium
Profit after tax
Revaluation Reserve
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Advance Financial Accounting (FIN-611)
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Transfer of profits
Part of profit paid to
as Reserves
share holder
as cash dividend
Capital Redemption General
Named
Retained
Reserve
Reserve
Reserve
Profits
Above diagram clearly shows that all reserves except share premium and revaluation
reserves are created out of the profits realized during the year. We may say that
reserves are the profits set aside for some specific purpose or otherwise. Accounting
entry for such setting aside of profits is:
Profit & loss a/c
Dr
Reserves a/c Cr
A standard format of balance sheet of a company looks like some what as under:
Limited Liability Company
Balance Sheet
As on December 31, 2009
Rs.
Rs.
Assets
Non Current Assets
***
Current Assets
***
Current Liabilities
(***)
***
***
Financed By (sources of finance)
Owners' Equity
Ordinary Share Capital
***
Reserves
Capital Reserves
***
***
***
Revenue Reserves
***
Non Current Liabilities
Loan from financial institutions
***
Loan Stocks/Term Finance Certificates
***
.
***
Balance sheet shows financial position of and entity. Upper part of the balance sheet shows
resources of an entity. Lower part of the balance sheet clearly shows the sources of finance.
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Table of Contents:
  1. ACCOUNTING FOR INCOMPLETE RECORDS
  2. PRACTICING ACCOUNTING FOR INCOMPLETE RECORDS
  3. CONVERSION OF SINGLE ENTRY IN DOUBLE ENTRY ACCOUNTING SYSTEM
  4. SINGLE ENTRY CALCULATION OF MISSING INFORMATION
  5. SINGLE ENTRY CALCULATION OF MARKUP AND MARGIN
  6. ACCOUNTING SYSTEM IN NON-PROFIT ORGANIZATIONS
  7. NON-PROFIT ORGANIZATIONS
  8. PREPARATION OF FINANCIAL STATEMENTS OF NON-PROFIT ORGANIZATIONS FROM INCOMPLETE RECORDS
  9. DEPARTMENTAL ACCOUNTS 1
  10. DEPARTMENTAL ACCOUNTS 2
  11. BRANCH ACCOUNTING SYSTEMS
  12. BRANCH ACCOUNTING
  13. BRANCH ACCOUNTING - STOCK AND DEBTOR SYSTEM
  14. STOCK AND DEBTORS SYSTEM
  15. INDEPENDENT BRANCH
  16. BRANCH ACCOUNTING 1
  17. BRANCH ACCOUNTING 2
  18. ESSENTIALS OF PARTNERSHIP
  19. Partnership Accounts Changes in partnership firm
  20. COMPANY ACCOUNTS 1
  21. COMPANY ACCOUNTS 2
  22. Problems Solving
  23. COMPANY ACCOUNTS
  24. RETURNS ON FINANCIAL SOURCES
  25. IASBíS FRAMEWORK
  26. ELEMENTS OF FINANCIAL STATEMENTS
  27. EVENTS AFTER THE BALANCE SHEET DATE
  28. PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
  29. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 1
  30. ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS 2
  31. BORROWING COST
  32. EXCESS OF THE CARRYING AMOUNT OF THE QUALIFYING ASSET OVER RECOVERABLE AMOUNT
  33. EARNINGS PER SHARE
  34. Earnings per Share
  35. DILUTED EARNINGS PER SHARE
  36. GROUP ACCOUNTS
  37. Pre-acquisition Reserves
  38. GROUP ACCOUNTS: Minority Interest
  39. GROUP ACCOUNTS: Inter Company Trading (P to S)
  40. GROUP ACCOUNTS: Fair Value Adjustments
  41. GROUP ACCOUNTS: Pre-acquistion Profits, Dividends
  42. GROUP ACCOUNTS: Profit & Loss
  43. GROUP ACCOUNTS: Minority Interest, Inter Co.
  44. GROUP ACCOUNTS: Inter Co. Trading (when there is unrealized profit)
  45. Comprehensive Workings in Group Accounts Consolidated Balance Sheet