COMPANY ACCOUNTS 1

<< Partnership Accounts Changes in partnership firm

COMPANY ACCOUNTS 2 >>

Advance Financial Accounting (FIN-611)

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.

Advance Financial Accounting (FIN-611)

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

Advance Financial Accounting (FIN-611)

1) Owned Equity

Owned equity comprises of:

a) Equity share capital (contributed by the member)

b) Reserves (realized/unrealized profits)

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

Advance Financial Accounting (FIN-611)

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

Bank a/c

1,000,000

Advance Financial Accounting (FIN-611)

Share Premium a/c

Rupees

Bank a/c

700,000

Bank a/c

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.

Capital

General

Retained

Premium

Redemption

Reserve

Profits

Reserve

Revaluation

Named/Specific

Reserve

Plant

Dividend

Replacement

Equalization

Reserve

Profits

Un-Realized Profits

Realized Profits

Share Premium

Profit after tax

Revaluation Reserve

Advance Financial Accounting (FIN-611)

Transfer of profits

Part of profit paid to

as Reserves

share holder

as cash dividend

Capital Redemption General

Named

Retained

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

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.

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.

Table of Contents: