Company Accounts, Capital Structure and Finance
Ownership and capital
A company is a separate legal entity owned by shareholders. Its capital structure may include:
- Ordinary shares – voting shares with variable dividends.
- Preference shares – fixed dividend, usually paid first, often no vote.
- Debentures – long-term borrowing, a liability, carrying fixed interest.
- Reserves – retained profits and share premium.
Key statements
Companies prepare an income statement, a statement of financial position and a statement of changes in equity. Equity comprises share capital, share premium, retained earnings and revaluation reserve.
Dividends and tax
Dividends are paid from retained profits, not from share capital, and are not an expense. Corporation tax is an expense deducted to reach profit after tax.
Traps
- Treating debentures as equity. They are liabilities and their interest is a finance cost.
- Treating a share issue as income. It increases share capital and share premium.
- Recording dividends as an expense.
- Forgetting that a bonus (capitalisation) issue uses reserves and issues no new cash.
- Confusing authorised share capital with issued share capital.
Worked example
A company issues 10,000 ordinary shares of $1 each at $1.50. Debit bank $15,000; credit share capital $10,000; credit share premium $5,000. If it later pays a dividend of $2,000 from retained earnings of $8,000, retained earnings fall to $6,000. Equity rises by the share issue but not by the dividend; the dividend simply moves money out of the company.