Limited Companies

Advantages of Limited Companies

1. Seperate Legal Existance so there is continuity

2. Limited Liabilities

3. More Capital can be raised

4. High Status in the community so easier to obtain loans

Disadvantages of Limited Companies

1. High Setting up Cost

2. Loss of control as there many Shareholders involved

3. Companies must comply with company act of 1985

What is an incoporation?

The legal formation of an entity seperate from its owners

Difference between Non-profit Organisation & Company Financial Statements

Limited Company	Non-profit Organisation
Has a Statement of Financial Position	Has a Balance Sheet
Shows Share Capital & Reserves	Shows Accumalated Funds
Has an Income & Expenditure account	Has an Income Statement
Has Reciepts & Payments account	Has a statement of Cash Flow

Advantages of Converting Partnership

1. More capital can be raised

2. Seperate legal existence so there is continuity

3. Limited Liabilities

4. Has a higher status and so easier to obtain loans and debentures

Difference between Ordinary Shares & Preference Shares

Ordinary Shares	Preference Shares
Variable Optional Dividends	Fixed Dividends and is Mandatory if sufficient profit is made
Have Voting Rights	No Voting Rights
Dividends is paid after preference shareholders are paid	Paid Dividends before Ordinary Shareholders are
Paid Capital Last at a event of liquidation	Paid before Ordinary Shares

What is Liquidation?

1. When the business does not have sufficient funds to discharge or pay of the loans. The business may have to sell the assets to pay off all the capital and loans

Types of Preference Shares

Cumulative Preference Shares

When the business is unable to pay the dividends for the current year , the amount is carried or accumalated to the next year

For example, the rate of dividends paid will increase next year

Non Cumulative Preference Shares

If the business is unable to pay dividends for a financial year then it is not accumalated but forgotten

However, this is only if the business does not have enough sufficient funds or else it is mandatory

Reedeemable Preference Shares

Preference shares that can be paid back by the company on a specific date. This is similar to a loan so it is not recorded under equity but liabilities

Non Reedeemable Preference Shares

Preference that can not be bought by the company on a specified date. This is part of equity as it is permanent

If you noticed under reserves, there is a reserve called capital redemption reserve. This is used to buy the preference shares back...

Advantages & Disadvantages of Issuing Ordinary Shares to:

Shareholder

1. More profit & dividends as there is no interest due to loan

2. Ordinary Shareholders have the same priority of repayment of capital, so less risk

3. Ordinary Shares have the same priority of payment of dividends

4. However, loss of control as ownership is diluted

The Company

1. Profit is greater as there is less interest also dividend may not have to be paid

2. Ordinary Shareholders have control over the company

This part is in the business' viewpoint. see Business Entity Concept

Advantages & Disadvantages of Issuing Preference Shares to:

Shareholder

1. No dilution of ownership as preference shares have no voting rights

2. Profit is fixed, so if profit increases, cash is retained ( improved cash flow )

The Company

1. No dilution or controlling as preference shares don't have voting rights

2. Preference shares have fixed dividends

This part is in the business' viewpoint. see Business Entity Concept

Difference between Ordinary Shares & cumulative Shares

1. Main Difference is that Cummalative dividends is fixed and is accumalated whereas, the ordinary shares are not accumalated and is optional and variable

2. No voting rights for cumulative preference shares whereas ordinary shares have voting rights

3. Same points as preference shares

Bank Loan or Share Issue

Bank Loan

1. The lenders must be convinced the business is able to meet the interest and repayment obligation

2. The lenders will be secured on the non current assets of the business // requires security and collateral

3. Issue of Debentures is much faster than share issue

4. Will increase gearing ratio and risk // may deter potential investor & Suppliers

5. Interest must be paid annually so profit & dividends will reduce

6. Loan must be repaid on a specific date

Share Issue

1. Longer time to issue

2. Doesn't required to be repaid

3. No interest so no reduction in profit

4. There is dilution of ownership so loss of control

5. Does not increase gearing or risk

6. Share issue may dilute share price

7. Share issue is expensive

This Question comes in many forms use the above to explain and advise whether to issue debentures or shares

Advantages of Debentures over the Shares

1. Faster to issue

2. No dilution or loss in ownership

3. Fixed rate of interest so can not increase if profits increases

4. Repayments are fixed so allow planning

An important point I forgot to mention is that the reasons why a partnership would admit a partner instead of a loan is similar to the points for share issue vs debentures

Difference between Ordinary Shares & Debentures

Ordinary Shares	Debentures
Owners	Creditors
Variable Optional Dividends	Fixed rate of interest must be be paid annually irrespective of profit
Have Voting Rights	No Voting Rights
Part of Equity	Part of long term loans and liabilities
Capital Repayment is paid after Debentures are paid	Debentures have the highest priority for capital repayment at a event of winding up

The marksheme usually say the word "discretion", this means that dividends to ordinary shares is optional

Where does Issue of Debentures Appear?

Debentures are long term liabilities so it is recorded in the statement of financial position as a non current liability

How does each issue affect profit:

Debenture issue

Interest is charged as expense that reduces profit in the income statement

Share Issue

Does not affect profit but does reduce retaining earnings in the statement of equity changes but no affect in the income statement

Difference between Capital & Revenue Reserves

Capital Reserves

1. Is not created by the transfer of profit.

2. Usually represent gains of unrealised profit

3. Can be used to issue bonus shares

4. Can not be used to pay dividends

Revenue Reserves are called Non Distributable reserves

Revenue Reserves

1. Is Created by the transfer of profit

2. Usually arises to strengthen the financial position of the business or for a specific purpose

3. Used to pay dividends

Capital Reserves are called Distributable reserves

Examples of Revenue / Distributable Reserves

1. Retained Earnings

2. General Reserves

3. Non Current Replacement Reserves

Examples of Capital / Non distributable reserves

1. Share premium

2. Revaluation reserves

3. Capital Redemption Reserves

Reasons for creating a General Reserve

1. To allocate profit for the reinvestment of the business

2. To pay future dividends

3. To use in the future when profits are low

What is meant by keeping the Reserves at most flexible form

Using capital reserves before revenue reserves to maintain maximum revenue reserves, to pay maximum dividends

Uses of Share premium Reserve

1. Issue of Bonus Shares

2. Company formation expenses

3. Cost of issuing debentures and shares

4. To pay premium on redemption of preference shares

Why the balance of Retained earning is lower than profit

1. Forwarding of a negative opening balance

2. High dividends paid

3. Issue of bonus shares

4. Transfer to general reserve

Double entry for Revaluation Reserves

1. Debit Non Current Assets & Provision for Depreciation

2. Credit Revaluation Reserves

Treatment of Proposed Final Dividends

Propsed dividends is not paid and is not a liability in the statement of financial position but is disclosed as note in the financial statement as it is a non adjusting event and adjusted in the next financial year

You will know more on what is an adjusting event later in A levels

Difference between Rights & Bonus Issues

1. Bonus shares are issued from reserves

2. Rights Issue raises cash and capital

Bonus shares are issued from reserves and there is an order in which you need to remember bonus shares are issued from

1. Share premium

2. Revaluation Reserves

3. Capital Redemption Reserves

4. Non Current Replacement Reserves

5. General Reserves

6. Retained Earnings

This is the same order of how statement of changes of equity is arranged

Why does a company make Bonus Shares

1. To liquidate capital reserves that can not be used to pay dividends

2. When profit is low, to reward shareholders without paying dividends

3. Good sign to potential investor

4. Helps release reserves with no impact to cash flow

5. Help to capitalise capital reserves but no change to net assets

6. Helps to increase the perception of business size by increaseing issued share capital

7. To match the long term Assets with Long term captial

Advantages of Bonus Shares

1. Does not affect cash flows as no dividends is paid // cash is retained

2. Good sign to potential investors

3. Does not dilute ownership as the ownership remains with existing shareholders

4. Helps to release capital reserves

Disadvantages of Bonus Shares

Does not raise any cash or capital

Benefits of Rights Issues

1. Cheaper than issuing normal shares

2. Raises cash // results in a cash inflow

3. No dilution in ownership as it remains with the ownership

4. More likely to subscribed than a new share

Disadvantages of Right Shares

Can cause the share price to fall

Difference between Rights Share & Bonus Shares

1. Rights share raises cash as it must be paid, where as bonus shares are free and so does not raise cash

2. Rights issue causes an increase in net assets/capital whereas bonus shares do not affect net assets

3. Rights issues can be rejected if share holder does not want to exercise his right whereas bonus shares are automatically added