Company accounting: share capital, financial statements and basic interpretation
What the examiner tests
This domain tests share issues, company financial statements and simple ratio interpretation.
Core rules
- Share capital: authorised capital is the maximum the company may issue; issued capital is what has been issued. Ordinary shares carry votes and variable dividends; preference shares carry a fixed dividend rate.
- Share premium arises when shares are issued above nominal value. It is capital, not income.
- Retained earnings are accumulated profits less losses and dividends. Dividends are distributions of profit, not expenses.
- Debentures are long-term borrowings and appear as liabilities, not equity.
- Basic ratios: gross profit margin = gross profit ÷ sales; net profit margin = net profit ÷ sales; current ratio = current assets ÷ current liabilities; liquid ratio = (current assets − inventory) ÷ current liabilities.
Worked example
A company issues 100,000 ordinary shares of N$1 each at N$1.20. Ordinary share capital = N$100,000; share premium = N$20,000. Profit for the year is N$50,000; dividends paid are N$15,000; retained earnings brought forward are N$20,000. Retained earnings carried forward = 20,000 + 50,000 − 15,000 = N$55,000. Current assets are N$80,000 including inventory N$30,000; current liabilities are N$40,000. Current ratio = 80,000 ÷ 40,000 = 2:1. Liquid ratio = (80,000 − 30,000) ÷ 40,000 = 1.25:1. Net profit margin on sales of N$250,000 = 50,000 ÷ 250,000 = 20%.
Traps
Do not credit share premium to profit and loss. Do not treat dividends as an expense. Do not include debentures in equity. Do not put authorised share capital in the statement of financial position; use issued capital. Do not confuse the current ratio with the liquid ratio.