IGCSE Accounting 0452 - 5.3 Limited Companies

This section covers the preparation of key financial statements for limited companies: the Income Statement, Statement of Changes in Equity, and Statement of Financial Position (also known as the Balance Sheet).

1. Introduction to Limited Companies

A limited company is a type of business structure where the liability of the owners (shareholders) is limited to the amount they have invested in the company. This means personal assets are protected from business debts.

Key features of a limited company include:

• Separate legal entity from its owners
• Limited liability for shareholders
• Can raise capital through the sale of shares

2. Income Statement

The Income Statement reports a company's financial performance over a specific period (e.g., a year). It shows the company's revenues, expenses, and the resulting profit or loss.

2.1 Structure of an Income Statement

The basic structure of an income statement is as follows:

Item	Amount (£)
Revenue
Cost of Goods Sold (COGS)
Gross Profit
Operating Expenses
Operating Profit (EBIT)
Interest Expense
Profit Before Tax (PBT)
Tax Expense
Profit After Tax (PAT)

Key terms:

• Revenue: Income generated from the company's main business activities.
• Cost of Goods Sold (COGS): The direct costs associated with producing goods sold.
• Gross Profit: Revenue - COGS
• Operating Expenses: Costs incurred in running the business (e.g., salaries, rent, utilities).
• Operating Profit (EBIT): Gross Profit - Operating Expenses
• Interest Expense: The cost of borrowing money.
• Profit Before Tax (PBT): Operating Profit - Interest Expense
• Tax Expense: The amount of tax payable to the government.
• Profit After Tax (PAT): Profit Before Tax - Tax Expense

2.2 Example Income Statement

Consider the following information for ABC Limited for the year ended December 31, 2023:

• Revenue: $150,000
• Cost of Goods Sold: $60,000
• Operating Expenses: $40,000
• Interest Expense: $5,000
• Tax Expense: $10,000

The Income Statement would be:

Item	Amount (£)
Revenue	$150,000
Cost of Goods Sold	($60,000)
Gross Profit	$90,000
Operating Expenses	($40,000)
Operating Profit (EBIT)	$50,000
Interest Expense	($5,000)
Profit Before Tax (PBT)	$45,000
Tax Expense	($10,000)
Profit After Tax (PAT)	$35,000

3. Statement of Changes in Equity

The Statement of Changes in Equity shows how the equity of a company has changed over a specific period. Equity represents the owners' stake in the company.

3.1 Components of Equity

The main components of equity are:

• Share Capital: The nominal value of shares issued to shareholders.
• Retained Earnings (or P&L Carry Forward): The accumulated profits of the company that have not been distributed as dividends.
• Other Reserves: Funds set aside for specific purposes.

3.2 Structure of a Statement of Changes in Equity

The statement typically shows the beginning and ending balances for each component of equity.

Item	Amount (£)
Beginning Balance (e.g., January 1, 2023)
Profit After Tax (PAT) for the Year
Dividends Paid During the Year
Ending Balance (e.g., December 31, 2023)

3.3 Example Statement of Changes in Equity

Consider the following information for ABC Limited:

• Beginning Share Capital: $50,000
• Profit After Tax: $35,000
• Dividends Paid: $10,000

The Statement of Changes in Equity would be:

Item	Amount (£)
Beginning Balance (Jan 1, 2023)	$50,000
Profit After Tax	$35,000
Dividends Paid	($10,000)
Ending Balance (Dec 31, 2023)	$75,000

4. Statement of Financial Position (Balance Sheet)

The Statement of Financial Position (Balance Sheet) shows a company's assets, liabilities, and equity at a specific point in time.

4.1 Accounting Equation

The fundamental accounting equation is the basis of the balance sheet: Assets = Liabilities + Equity

4.2 Components of a Balance Sheet

• Assets: Resources controlled by the company that are expected to provide future economic benefits. Examples include:
• Current Assets: Assets expected to be converted to cash within one year (e.g., cash, inventory, receivables).
• Non-Current Assets: Assets with a useful life of more than one year (e.g., property, plant, and equipment (PPE), intangible assets).
• Liabilities: Obligations of the company to external parties. Examples include:
• Current Liabilities: Liabilities due within one year (e.g., payables, short-term loans).
• Non-Current Liabilities: Liabilities due in more than one year (e.g., long-term loans, deferred tax liabilities).
• Equity: The owners' stake in the company (as calculated in the Statement of Changes in Equity).

4.3 Structure of a Balance Sheet

The balance sheet is presented in a format that shows assets on one side and liabilities and equity on the other.

Assets	Amount (£)
Current Assets
Non-Current Assets
Total Assets

Liabilities	Amount (£)
Current Liabilities
Non-Current Liabilities
Total Liabilities

Equity	Amount (£)
Share Capital
Retained Earnings
Other Reserves
Total Equity

The accounting equation must always balance: Total Assets = Total Liabilities + Total Equity

4.4 Example Statement of Financial Position

Consider the following information for ABC Limited as of December 31, 2023:

• Cash: $20,000
• Inventory: $30,000
• Receivables: $40,000
• Property, Plant & Equipment: $80,000
• Payables: $25,000
• Long-Term Loan: $50,000
• Share Capital: $50,000
• Retained Earnings: $15,000

The Statement of Financial Position would be:

Assets	Amount (£)
Current Assets	$90,000
Non-Current Assets	$80,000
Total Assets	$170,000

Liabilities	Amount (£)
Current Liabilities	$25,000
Non-Current Liabilities	$50,000
Total Liabilities	$75,000

Equity	Amount (£)
Share Capital	$50,000
Retained Earnings	$15,000
Total Equity	$65,000

Verification: Total Assets ($170,000) = Total Liabilities ($75,000) + Total Equity ($65,000) = $140,000. There appears to be an error in the provided data, as the equation does not balance. This highlights the importance of accurate data entry.