Chapter

Chapter X
26
The Nature of Limited Companies
Chapter Title and their Capital

An
Introduction to
Financial
Accounting
9th edition

Andrew Thomas & Anne Marie

Ward
 Objectives
By the end of the lecture (and with private study) students should
be able to:
• Describe the main characteristics of limited companies with particular
reference to how these differ from partnerships;
• Describe the different classes of companies limited by shares;
• Outline the legal powers and duties of limited companies with
reference to their Memorandum and Articles of Association;
• Explain the nature and types of shares and loan capital issued;
• Outline the procedure relating to the issue of shares and debentures;
• Explain the nature of a share premium, debenture discount,
preliminary expenses, interim and final dividends;
• Describe the contents of a company’s statutory books;
• Describe the purpose and proceedings of a company’s annual general
meeting.

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Organisations recognised by law as having
the capacity to enter into contracts
Unincorporated/Bodies sole – sole traders and
partnerships.

Incorporated/Bodies corporate -
Formed by either:
(1) Royal Charter (e.g. ICAEW);
(2) Specific Act of Parliament (e.g. the BBC);
(3) General Act of Parliament (e.g. Companies Act 2006
– most companies).

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 Types of companies
• Unlimited companies

• Companies limited by guarantee

• Companies limited by shares

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 The characteristics of
companies limited by shares
• Separate legal entity.
• Perpetual existence.
• Liability of shareholders is limited to the
nominal value of their equity shares.
• Ownership is legally separate from the
management.
• Each share carries one vote.
• Minimum of 2 shareholders; no maximum.

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 Classes of companies
limited by shares
Public Limited Company (PLC)
(1) Registered as such
(2) Shares are tradable on exchanges such as the
London Stock Exchange. The public can purchase the
shares

Private Limited Company (Ltd)

(1) Not permitted to make a public offer of shares for
sale

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 The legal powers and duties
of limited companies
Memorandum of Association
(1) name and address
(2) limit of liability
(3) objects/type of industry
(4) authorised share capital
(5) public or private company

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 The legal powers and duties
of limited companies
Articles of Association
Sets out the rights of shareholders between
themselves (e.g. regarding dividend priorities),
and regulations relating to the issue of shares,
borrowing powers, meetings, appointment of
directors, etc.

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 Company formation
Certificate of Incorporation – issued on incorporation
(like a birth certificate)

Trading certificate – Issued by the Registrar when the

company meets certain regulations in respect of its
capital structure – required before trading can
commence.

Preliminary/promotion/formation expenses – costs of

forming a company

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 Sources of long-term capital
• Ordinary/equity shares

• Preference shares

• Debentures/loan stock

• All the shares and debentures/loan stock of

UK companies have a fixed nominal/face/ par
value (e.g. 10 pence, 25 pence, £1, £100).

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 The characteristics of
equity shares
• Equity shareholders are the owners of the company
and thus entitled to vote at general meetings (e.g. to
elect directors).
• Entitled to a dividend, the amount of which is
decided annually by the directors and is an
appropriation of profit.
• Last to be repaid in the event of liquidation.
• Non-repayable (except on liquidation).
• Rights as specified in the Articles of Association.
• Dividends are non-deductible from the company’s
profit for tax purposes.

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 The characteristics of
preference shares
• No voting rights.
• Entitled to a fixed rate of dividend which has priority
over the equity dividends and is an appropriation of
profit.
• Repaid before the equity shareholders in the event of
liquidation.
• Non-repayable (except on liquidation).
• Rights as specified in the Articles of Association.
• Dividends are non-deductible from the company’s
profit for tax purposes.

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 Types of preference shares
• Non-cumulative – waived dividends are lost.

• Cumulative – dividends not paid in previous years

are accrued and must be paid before a dividend is
paid to equity shareholders.

• Redeemable – the company buys back the shares,

typically at nominal value.

• Participating – the holder has the right to receive a

larger dividend if the company does well.

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 The characteristics of
debentures/loan stock
• Also called corporate bonds

• No voting rights

• Entitled to a fixed rate of interest which has priority over all

the dividends and is a charge against income (i.e. an
expense).

• Repaid before all the shareholders in the event of

liquidation.

• Normally repayable after a fixed period of time (e.g. 10, 20,

30 years) from the date of issue.
• Rights as specified in the terms of issue.

• Interest is deductible from the company’s profit for tax

purposes. © McGraw-Hill Education 2019
Types of debentures/loan stock
• Unsecured/naked – no security provided by the
assets of the company.

• Fixed charge – secured on a specific asset (which

cannot be sold).

• Floating charge – secured on a type of asset, which

can change, so long as a minimum level of asset is
maintained (e.g. inventories).

• Convertible – can be exchanged for equity shares.

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 The issue of shares and debentures:
an illustration
Pence
Nominal value 100
Share premium 50
Issue price 150
Market price 170

Payable on Application 60
Payable on Allotment 30
1st Call 40
2nd Call 20
Issue price 150

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 Interim and final equity dividends
• Interim dividend – paid halfway through the
accounting year when the profit for the first
six months is known.

• Final dividend – additional to the interim

dividend. Paid just after the end of the
accounting year when the profit for the year
is known.

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Dividends on preference shares and interest
on debentures/loan stock
These are frequently paid in two instalments,
one halfway through the accounting year and
the other at the end of the year. However, the
latter is often outstanding at the end of the
year.

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 The books of account
and published financial statements
All companies are required by law to:
1. Maintain proper ‘books of account’ or other records
of their business transactions.
2. (a) Prepare annual published financial statements
including a statement of comprehensive income, a
statement of financial position and an auditors
report.
(b) Send each equity shareholder and the Registrar
of Companies a copy of the annual published
financial statements.
3. Maintain statutory books.
4. Hold an annual general meeting (AGM).

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 Audit report
• Required by law – some companies
• Independent qualified accountants
• Covers the statement of comprehensive
income, statement of financial position,
statement of cash flows and notes.
• The other information in the annual
return also has to be reviewed by the
auditors to ensure that it is consistent
with the information in financial
statements.
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The statutory books

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 The Annual Return
Annual return – sent to the Registrar of
Companies showing changes in the statutory
books during the year.

The statutory books and annual return are open

to inspection by the public at Companies House
and the company’s registered office (except the
minute book of directors meetings).

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The annual general meeting (AGM)
All companies are required by law to hold an annual
meeting of the company’s equity shareholders at which
they vote on the following:
• To receive and adopt the annual published accounts
– this provides an opportunity to question the
directors on the contents of the accounts.
• To declare and adopt the proposed final dividend on
the equity shares.
• To elect (or remove) directors.
• To appoint auditors.

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 Summary – some key points
• Companies are separate legal entities, distinct from their owners.

• Specific legislation – the Companies Act.

• The owners’ liability is limited to the amount they paid for the
share.

• Companies powers and owner rights are laid down in the

memorandum and articles of association.

• Companies typically have equity shares, preference shares,

dividends, debentures and loan stock.

• Companies must issue published financial statements each year

for its owners.

• Companies have to keep certain records (statutory books) under

companies legislation. © McGraw-Hill Education 2019
 Student - study action
• Read chapter 26.

• Then - try to explain the key terms and concepts (check

your answer with the chapter and the online glossary).

• Try the review questions (check your answers with the

chapter)

• Try the exercise questions with an asterisk (solutions

are available in the appendix)

• Try the exercise questions required by your tutor

(solutions to be provided by the tutor at their
discretion)

• Try the learning activities on the student online

learning centre (www.mcgraw-hill.co.uk/textbooks/thomas)
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