Back to: Financial Accounting
Welcome to another week!
This week, we’ll look at Limited Companies—a more complex and widely-used business structure. Limited companies are separate legal entities, distinct from their owners, and they are required to follow specific accounting and reporting rules.
Accounting for Limited Companies
1. What is a Limited Company?
A Limited Company (Ltd) is a business structure where the owners (shareholders) are not personally liable for the company’s debts. The liability of each shareholder is limited to the value of the shares they hold in the company.
Key features of limited companies:
Separate Legal Entity: The company exists independently of its owners.
Limited Liability: Shareholders are not personally liable for company debts.
Shares: Ownership is divided into shares, and shareholders receive dividends based on the number of shares they own.
2. Types of Limited Companies
Private Limited Company (Ltd): A company whose shares are not available to the public. It’s typically owned by a small group of investors or family members.
Public Limited Company (PLC): A company whose shares are publicly traded on a stock exchange. A PLC is subject to stricter regulatory requirements.
3. The Accounting Structure for a Limited Company
In a limited company, the financial structure is more complex compared to a partnership or sole trader. Here are the key features of limited company accounting:
Share Capital
Limited companies raise capital by issuing shares. The initial capital is recorded in the Share Capital section of the balance sheet. There are typically two types of share capital:
Ordinary Shares: These are the most common type and give shareholders voting rights and the right to dividends.
Preference Shares: These give shareholders priority in receiving dividends but usually don’t carry voting rights.
Reserves
Companies may have retained earnings (profits not distributed as dividends) that accumulate over time and are recorded in the retained earnings reserve. This is part of shareholders’ equity in the balance sheet.
4. Financial Statements for Limited Companies
Similar to partnerships, limited companies prepare a set of financial statements, but with more detailed disclosures due to regulatory requirements.
Income Statement (Profit & Loss Statement): Shows the company’s revenues, costs, and profits.
Includes items like revenue, cost of sales, operating expenses, and profit before tax.
Tax and dividends are deducted to calculate net profit.
Balance Sheet: The balance sheet for a limited company will include:
Non-current assets: Property, plant, equipment, and intangible assets.
Current assets: Cash, inventory, and receivables.
Liabilities: Short-term and long-term debts.
Equity: Share capital and retained earnings.
Cash Flow Statement: Tracks cash inflows and outflows, as we covered previously, and helps users understand how cash is generated and spent.
Notes to the Financial Statements: These provide additional details and disclosures about the financial statements, such as accounting policies, pensions, and any contingent liabilities.
5. Example: Limited Company Financials
Let’s say XYZ Ltd has the following figures for the year:
Revenue: N500,000
Cost of Sales: N300,000
Operating Expenses: N120,000
Interest: N10,000
Tax: N15,000
Net Profit: N55,000
The Profit and Loss Account would look like this:
Description
Amount (N)
Revenue
500,000
Less: Cost of Sales
(300,000)
Gross Profit
200,000
Less: Operating Expenses
(120,000)
Operating
Profit
80,000
Less: Interest
(10,000)
Profit Before Tax
70,000
Less: Tax
(15,000)
Net Profit
55,000
The Balance Sheet or Stamenwould list assets, liabilities, and shareholders’ equity as we discussed earlier.
6. The Dividends and Retained Earnings
At the end of the year, the company may choose to pay dividends to shareholders. The decision to pay dividends is usually made by the Board of Directors, based on the company’s profits and future investment needs. The dividend paid is deducted from the retained earnings.
Example: Dividend Calculation
If Ajanlekoko and Sons Ltd has a net profit of N55,000 and the company declares a 50% dividend payout, it would distribute N27,500 to shareholders and retain the rest (N27,500) in the business.
Conclusion
In previous weeks, we explored the accounting principles and financial statements related to Partnerships, understanding how profits are shared, capital accounts are managed, and how partnerships prepare financial reports.
We focused on Limited Companies, diving into their unique financial structure, including share capital, the preparation of income statements and balance sheets, and understanding dividends and retained earnings.
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