Revise Limited companies for Cambridge 9706 (1.5.4)

A limited company is a distinct legal entity, separate from its owners (shareholders). This grants the company the ability to own assets and incur liabilities in its own name. The primary advantage for shareholders is limited liability, meaning their personal assets are protected; their financial risk is restricted to the amount invested in the company's shares. Capital is raised by issuing shares. The two main classifications are authorised share capital, the maximum value of shares a company can issue, and issued share capital, the nominal value of shares that have actually been sold to shareholders.

Shares are primarily divided into Ordinary Shares and Preference Shares. Ordinary shareholders are the true owners, bearing the highest risk and reward. They have voting rights and receive a variable dividend, which is paid only after all other claims (like preference dividends) are settled. Preference Shares offer a lower-risk investment. They typically carry a right to a fixed-rate dividend (e.g., 5% Preference Shares) that must be paid before any ordinary dividend. They usually do not have voting rights. Preference shares can be cumulative, meaning any unpaid dividends from a poor profit year are carried forward and must be paid in future years before ordinary shareholders get anything.

When a company issues shares, it can do so at their nominal value (par) or at a price higher than their nominal value (at a premium). If 100,000 $1 shares are issued at par, the entry is Dr Bank $100,000, Cr Ordinary Share Capital $100,000. If issued at $1.20, the extra $0.20 per share is the premium. The entry becomes: Dr Bank $120,000, Cr Ordinary Share Capital $100,000 (always the nominal value), and Cr Share Premium $20,000. The Share Premium account is a capital reserve, not distributable as cash dividends. It reflects capital contributed by shareholders above the par value and its use is legally restricted, such as for issuing bonus shares.

Company reserves are broadly categorised into capital reserves and revenue reserves. Capital reserves arise from non-trading, capital transactions. Key examples include the Share Premium account (from issuing shares above par) and the Revaluation Reserve. This is created when a non-current asset's fair value is deemed to be materially higher than its carrying amount; the double entry is Dr Asset and Cr Revaluation Reserve. Capital reserves are generally non-distributable as cash dividends. In contrast, revenue reserves are generated from trading profits. The main revenue reserve is Retained Earnings, which represents the accumulated net profits after tax and dividends. A company may also create a General Reserve by voluntarily transferring an amount from retained earnings to set aside profits for future expansion. The accounting entry is Dr Retained Earnings, Cr General Reserve. Revenue reserves are distributable to shareholders as dividends.

Unlike a sole trader's profit, a company's profit after tax is formally appropriated. This involves decisions on paying dividends and transferring funds to reserves. Dividends are the return paid to shareholders. Interim dividends are paid during the year, while final dividends are proposed after the year-end. These appropriations are not expenses; they are distributions of profit. The Statement of Changes in Equity (SOCIE) is a key financial statement that details these movements. It reconciles the opening and closing balances of each equity component (Share Capital, Share Premium, Revaluation Reserve, Retained Earnings), showing how profit for the year, dividends, and new share issues have affected the overall equity of the company during the period.