Public and private companies

The form and extent of the accounts of limited companies are governed by the Companies Act 1985.

There are two main types of limited company:

• public limited companies, which have Plc after their name; and
• private limited companies, which have Ltd after their name.

Public companies have to disclose more information than private companies.

The company as a ‘person’

The main difference between the company and other business entities is that it is a legal entity or ‘person’ quite separate from the shareholders. The partnership and the sole proprietorship on the other hand are inseparable from the people involved: if these two businesses cannot pay their debts then the partners or proprietors may be called upon to settle them personally, because ‘the business’s debts’ are in reality ‘their debts’. On the other hand a company’s debts are its debts alone. The shareholders cannot be called upon to settle the company’s debts: their liability is limited to the original value of their shares. In law, a company is a separate legal ‘person’ (though obviously not a human one), and so has its own rights and obligations under the law.

SHARE CAPITAL

The capital account has its own special treatment in limited company accounts. The capital of limited companies is divided into shares, which people can buy and sell. A share in the capital of the company entitles the shareholder to a share of the profits of the company—just as a partner owning capital in a firm is entitled to profits.

Authorised share capital

Authorised share capital is just a statement of the share capital a company is authorised to issue, not what it has issued. The issued share capital is the amount of that limit that it actually has issued, i.e. the shares it has sold. It is only this latter amount that actually represents the company’s capital.

The authorised share capital shows the nominal value of the company’s shares. That is a rather arbitrarily chosen rounded-figure value at incorporation of the business selected for the purpose of making it easy to divide up the equity of the firm. Suppose a sole proprietor, whose total net assets are £360,000 is incorporating his business in order to take in two other investors, but he wishes to retain the controlling share of 51%. Allocation of shares representing the net assets would be a messy business unless an easily divisible figure was used to represent the £360,000 net asset value. A figure of £100,000 can be registered as its authorised share capital, divided into 100,000 ordinary shares of £1, each of which represents £3.60 of the actual share capital.

Even if the authorised share capital did reflect exactly the net assets of the business, as might be the case where a new business is incorporated from scratch, five years later the company may be worth twice as much as when it started because of reinvested profits. Therefore any shares still to be issued will be worth probably twice as much as they were when the company started even though their nominal value will still be listed as the same figure as when the company was formed. It is necessary to keep them listed at their nominal value because that reflects the nominal proportion of the share capital that they represent. The difference between the nominal value and the market value is know as share premium. The excess over nominal value that is charged for the shares is posted to share premium account and shows up in the balance sheet as such.

Ordinary and preference shares

There is, however, a difference, because limited companies can have different kinds of shares with different kinds of entitlements attached to them, e.g. ordinary shares, and preference shares.

• Preference shares receive a fixed rate of dividend (profit share), provided sufficient profit has been made. For example it might be 10% of the original value of the preference shares.
• Ordinary shares have no such limit on their dividend, which can be as high as the profits allow. However, they come second in the queue, so to speak, if the profit is too little to pay dividends to both the preference and ordinary shareholders.

Furthermore, a company is allowed to retain part of the profits to finance growth. How much, is up to the directors. Unless otherwise stated in the company’s memorandum of association, preference shares are cumulative, in other words any arrears of dividend can be carried forward to future years until profits are available to pay them. Since the Companies Act 1985, a company is allowed to issue redeemable shares, preference and ordinary. These are shares that the company can redeem (buy back) from the shareholder at his request.

Debentures

Some of the net assets of a company may be financed by debentures. These are loans, and interest has to be paid on them. Since debentures have to be repaid, we have to show them as liabilities in the balance sheet.