Section A: Key terms and recall
Define the term 'limited liability'.
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Limited liability means that the owners of a company (shareholders) are only responsible for the company's debts up to the amount they have invested in the company. They are not personally liable for the company's debts. [2 marks]
What are the three types of businesses a limited company can be?
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1. Trading business 2. Service business 3. Manufacturing business [1 mark each]
List two advantages of operating as a limited company.
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1. Limited liability (protection for personal assets) 2. Easier to raise capital through selling shares [1 mark each]
List two disadvantages of operating as a limited company.
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1. More regulatory requirements and paperwork 2. Higher accounting and legal costs [1 mark each]
What is the difference between issued, called-up, and paid-up share capital?
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1. Issued share capital: The total amount of shares that the company is authorised to issue. 2. Called-up share capital: The amount of shares that have been issued and the company has requested payment for. 3. Paid-up share capital: The amount of shares that have been issued, called-up, and paid for by the shareholders. [1 mark each]
Section B: Applying your knowledge
GreenTech Ltd is a manufacturing company. Explain how limited liability benefits the shareholders of GreenTech Ltd.
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Limited liability protects the personal assets of the shareholders. If GreenTech Ltd incurs debts it cannot pay, the shareholders are only liable for the amount they have invested in the company. Their personal assets, such as their homes or savings, are not at risk. [2 marks]
HealthCare Services Ltd is a service company. What are two advantages of HealthCare Services Ltd operating as a limited company?
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1. Easier to raise capital: HealthCare Services Ltd can issue shares to raise funds for expansion or new projects. 2. Perpetual succession: The company continues to exist even if the shareholders change, providing stability and continuity. [1 mark each]
EcoBuild Ltd is a trading company. What are two disadvantages of EcoBuild Ltd operating as a limited company?
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1. More regulatory requirements: EcoBuild Ltd must comply with various legal and regulatory requirements, such as filing annual reports and holding annual general meetings. 2. Higher accounting and legal costs: Maintaining the company's financial records and complying with regulations can be expensive. [1 mark each]
Innovate Ltd has the following capital structure:
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Total equity = Preference share capital + Ordinary share capital + General reserve + Retained earnings = £50,000 + £100,000 + £30,000 + £20,000 = £200,000 [2 marks]
TechSolutions Ltd has issued 10,000 ordinary shares at £1 each. The company has called up £50,000 of these shares, and shareholders have paid up £40,000. Calculate the issued, called-up, and paid-up share capital of TechSolutions Ltd.
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1. Issued share capital = Number of shares issued × Par value per share = 10,000 × £1 = £10,000 2. Called-up share capital = £50,000 (as given) 3. Paid-up share capital = £40,000 (as given) [1 mark each]
Section C: Explain and analyse
Explain the difference between ordinary share capital and loan capital (debentures). Provide examples of each.
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1. Ordinary share capital: This is the capital raised by a company by issuing ordinary shares to shareholders. Ordinary shares carry voting rights and the right to receive dividends, but the amount of dividends is not fixed and depends on the company's profits. Example: A company issues 1,000 ordinary shares at £10 each, raising £10,000 in capital. 2. Loan capital (debentures): This is the capital raised by a company by issuing debentures, which are essentially loans from investors. Debentures carry a fixed rate of interest and do not carry voting rights. Example: A company issues £50,000 in debentures with a 5% annual interest rate, paying investors £2,500 per year in interest. [2 marks each]
Describe the process of preparing a statement of profit or loss, a statement of changes in equity, and a statement of financial position for a limited company. Explain the purpose of each statement.
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1. Statement of profit or loss: This statement shows the company's revenues, expenses, and profit or loss for a specific period. It is prepared by taking the company's revenue and subtracting the expenses incurred to generate that revenue. The purpose is to show the company's financial performance over the period. 2. Statement of changes in equity: This statement shows the changes in the company's equity over the period, including the issuance of new shares, the payment of dividends, and the transfer of profits to reserves. The purpose is to show how the company's equity has changed over the period. 3. Statement of financial position: This statement shows the company's assets, liabilities, and equity at a specific date. It is prepared by listing the company's assets on one side and its liabilities and equity on the other. The purpose is to show the company's financial position at the end of the period. [2 marks each]
Section D: Challenge
GlobalTrade Ltd is a trading company with the following trial balance as at 31 December 2023:
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1. Statement of profit or loss: - Revenue: £200,000 - Cost of sales: £120,000 + (£25,000 - £20,000) = £125,000 - Gross profit: £200,000 - £125,000 = £75,000 - Operating expenses: £30,000 + £5,000 (depreciation) + £1,000 (irrecoverable debts) - £1,500 (prepaid expenses) + £2,000 (accrued expenses) = £36,500 - Profit before tax: £75,000 - £36,500 = £38,500 2. Statement of changes in equity: - Opening retained earnings: £40,000 - Profit for the year: £38,500 - Closing retained earnings: £40,000 + £38,500 = £78,500 3. Statement of financial position: - Non-current assets: £100,000 - (£20,000 + £5,000) = £75,000 - Current assets: £20,000 (trade receivables) - £1,000 (irrecoverable debts) - £1,000 (allowance for irrecoverable debts) + £5,000 (inventory) + £10,000 (bank) + £5,000 (cash) = £38,000 - Current liabilities: £15,000 (trade payables) + £2,000 (accrued expenses) = £17,000 - Equity: £50,000 (ordinary share capital) + £30,000 (general reserve) + £78,500 (retained earnings) = £158,500 - Total assets: £75,000 (non-current assets) + £38,000 (current assets) = £113,000 - Total liabilities and equity: £17,000 (current liabilities) + £158,500 (equity) = £175,500 [2 marks for each statement, 2 marks for calculations]