How do you prepare the income statement and statement of financial position of a limited company, including share capital, reserves and dividends?
Preparation of the income statement and statement of financial position for a limited company, including ordinary and preference share capital, share premium, the general reserve, retained earnings, dividends, debentures and the appropriation of profit.
A focused answer to the SQA Higher Accounting limited company content, covering ordinary and preference share capital, share premium, reserves, retained earnings, dividends, debentures, and how a company appropriates profit and presents its equity.
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What this dot point is asking
The SQA wants you to prepare the final accounts of a limited company, which differ from a sole trader's mainly in how profit is appropriated and how the equity section is built from share capital and reserves. You must handle ordinary and preference shares, share premium, reserves, retained earnings, dividends and debentures.
How a company differs from a sole trader
A company is a separate legal person owned by its shareholders and run by directors. Profit belongs to the company, not to one owner, so instead of capital plus profit minus drawings, a company shows share capital and reserves, and it distributes profit as dividends. The other differences the SQA tests are the appropriation of profit and the financing through shares and debentures.
Share capital and debentures
Ordinary shares carry ownership, voting rights and a variable dividend; ordinary shareholders take the most risk and the most reward. Preference shares carry a fixed-rate dividend paid before ordinary dividends and rank ahead of ordinary shares for repayment, but usually carry no vote. Debentures are long-term loans: the holder is a creditor, the interest is fixed and must be paid regardless of profit, and it is an expense, not an appropriation.
The appropriation of profit
Dividends are an appropriation of profit, not an expense, so they appear after profit for the year, never in the calculation of profit. Debenture interest, by contrast, is an expense and reduces profit for the year before any appropriation.
The equity section
The statement of financial position groups the financing into equity and liabilities. Equity lists ordinary share capital, preference share capital, share premium, general reserve and retained earnings. Non-current liabilities include debentures and other long-term loans. The total of equity plus liabilities equals total assets, just as a sole trader's statement balances.
Try this
Q1. A company has 50,000 £1 ordinary shares and declares a 12p dividend. Calculate the ordinary dividend. [1 mark]
- Cue. 50,000 x £0.12 = £6,000.
Q2. Profit available is £80,000, total dividends £14,000 and the transfer to general reserve £10,000. Calculate retained earnings carried forward. [2 marks]
- Cue. £80,000 - £14,000 - £10,000 = £56,000.
Q3. State whether debenture interest is an expense or an appropriation, and why. [2 marks]
- Cue. An expense, because debentures are loans and the interest must be paid regardless of profit.
Exam-style practice questions
Practice questions written in the style of SQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SQA Higher style6 marksA company has profit for the year before appropriation of £120,000 and retained earnings brought forward of £45,000. It has 200,000 £1 ordinary shares and pays an ordinary dividend of 8p per share. It also has £50,000 of 6% preference shares and transfers £20,000 to the general reserve. Calculate the retained earnings carried forward.Show worked answer →
Ordinary dividend = 200,000 shares x £0.08 = £16,000 (1 mark).
Preference dividend = 6% of £50,000 = £3,000 (1 mark).
Total appropriations = ordinary dividend + preference dividend + transfer to general reserve = £16,000 + £3,000 + £20,000 = £39,000 (1 mark).
Profit available = profit for the year + retained earnings brought forward = £120,000 + £45,000 = £165,000 (1 mark).
Retained earnings carried forward = £165,000 - £39,000 = £126,000 (2 marks). Markers reward both dividends, the reserve transfer, the profit available and the closing retained earnings.
SQA Higher style4 marksExplain the difference between an ordinary share and a debenture from the company's point of view, covering ownership, the return paid, and the order of payment.Show worked answer →
An ordinary share is part of the company's equity: the holder is an owner (member) of the company (1 mark). A debenture is long-term debt: the holder is a lender, not an owner (1 mark).
Ordinary shareholders receive a dividend, which is variable and only paid if profits and the directors allow; debenture holders receive a fixed rate of interest that must be paid whether or not the company is profitable (1 mark).
Debenture interest ranks ahead of dividends and debenture holders rank ahead of shareholders for repayment if the company is wound up (1 mark). Markers reward the ownership, the return and the priority for each.
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Sources & how we know this
- SQA Higher Accounting Course Specification — SQA (2023)