What you'll learn
A limited company differs from a sole trader or partnership in one decisive respect: it is a separate legal person. It owns its own assets, owes its own debts, and its owners — the shareholders — risk only what they paid for their shares. That single fact drives everything distinctive about company accounts: share capital instead of capital, dividends instead of drawings, reserves, and a legal framework governing what may be distributed.
A non-profit organisation — a sports club, a church group, a community association — is different again. It exists to provide a service to its members rather than to earn a profit for an owner, so it has no capital account and no profit. It has an accumulated fund and a surplus or deficit for the year, and its principal income is subscriptions rather than sales.
By the end of this topic you should be able to distinguish share capital from reserves, account for dividends and for bonus and rights issues, prepare an income and expenditure account from a receipts and payments account, and calculate subscription income adjusted for amounts owing and prepaid.
Key terms and definitions
Ordinary shares — the basic ownership stake. Ordinary shareholders vote, receive a variable dividend and rank last on a winding up.
Preference shares — shares carrying a fixed dividend paid before the ordinary dividend, usually without voting rights.
Share premium — the excess over nominal value received when shares are issued. It is a reserve, not share capital, and its use is restricted.
Retained earnings — accumulated profits not yet distributed. The main distributable reserve.
Bonus issue — free shares issued to existing shareholders by capitalising reserves. No cash is received.
Rights issue — new shares offered to existing shareholders, usually below market price. Cash is received.
Receipts and payments account — a summary of the cash book of a non-profit organisation. Cash only, capital and revenue items mixed together.
Income and expenditure account — the equivalent of an income statement for a non-profit organisation, prepared on the accruals basis.
Accumulated fund — the equivalent of capital for a non-profit organisation: assets less liabilities.
Core concepts
Share capital and reserves
Share capital is the nominal value of the shares issued. If 400,000 ordinary shares of $1 each are issued at $1.50, share capital is $400,000 and the remaining $200,000 goes to share premium. The two are never merged.
Reserves divide into two kinds. Distributable reserves — principally retained earnings — may be paid out as dividends. Non-distributable reserves, such as share premium and any revaluation reserve, may not, because they protect the capital that creditors rely on. A question asking what a company may legally distribute is asking you to identify which reserves are which.
Preference dividends are paid before ordinary ones and at a fixed rate. Ordinary dividends are proposed by the directors and vary with performance, which is why the ordinary shareholder carries more risk and, in a good year, more return.
Bonus and rights issues
A bonus issue capitalises reserves: the company issues free shares and moves an equal amount out of reserves into share capital. No cash comes in and no shareholder is better off, because each now holds more shares in a company worth exactly what it was worth before. Its purpose is to bring a high share price down to a more tradeable level and to formalise reserves the directors do not intend to distribute.
A rights issue raises cash. Shares are offered to existing shareholders in proportion to their holdings, usually at a discount, so that ownership proportions are preserved for those who take up their rights.
The distinction is frequently examined and easily stated: a bonus issue changes the composition of equity, a rights issue increases it.
Why a non-profit organisation's accounts differ
The receipts and payments account is simply the cash book summarised. It mixes capital and revenue items, ignores amounts owing and prepaid, and tells a member nothing about whether the club lived within its means during the year.
The income and expenditure account fixes all three problems. It includes only revenue items, adjusts for accruals and prepayments, charges depreciation, and produces a surplus or deficit — never a profit, and the word matters in a mark scheme.
The accumulated fund replaces capital and is calculated the same way: assets less liabilities at the start of the year. A common question opens by asking you to compute it before anything else can be prepared.
Trading activities inside a non-profit organisation
Most clubs run something that trades — a bar, a canteen, a shop, an annual fundraising dance. These are handled separately from the main account, because members want to know whether the bar washes its own face rather than seeing its takings buried among subscriptions.
The usual treatment is a small trading account for each activity, prepared exactly as a trading account would be for a business: takings less cost of sales gives a gross profit, from which the direct costs of running that activity — the barman's wages, the hire of the hall for the dance — are deducted. Only the resulting profit or loss on the activity is then carried into the income and expenditure account as a single line.
This is worth getting right because it is where the vocabulary trap bites hardest. The club as a whole reports a surplus or a deficit, but a trading activity inside it genuinely does report a profit or a loss — it is trading. Examiners award marks for both words used correctly in the same answer.
Subscriptions
Subscriptions are the standard adjustment question, and they run in the opposite direction to an expense. Start with cash received. Deduct arrears collected that related to last year and deduct any amount received in advance this year, because neither is income of this period. Add subscriptions owing at the year end and add any amount that was received in advance last year, because both are income of this period.
Many clubs write off long-standing arrears rather than carry them, on the ground that a member who has not paid for two years has effectively left. If a question says so, the write-off is an expense.
Worked examples
Example 1 — Share issue at a premium (4 marks)
A company issues 400,000 ordinary shares of $1 each at $1.50, fully paid.
Cash received = 400,000 × $1.50 = $600,000. Share capital = 400,000 × $1.00 = $400,000. Share premium = 400,000 × $0.50 = $200,000.
Check: $400,000 + $200,000 = $600,000. The premium is a non-distributable reserve and cannot be paid out as a dividend.
Example 2 — Bonus issue (4 marks)
The company above, with 400,000 $1 ordinary shares in issue, makes a bonus issue of one for four out of retained earnings.
New shares = 400,000 ÷ 4 = 100,000 shares. Amount capitalised = 100,000 × $1 = $100,000.
Share capital rises from $400,000 to $500,000; retained earnings fall by $100,000. Total equity is unchanged, and no cash has moved. A shareholder who held 4,000 shares now holds 5,000 and is no wealthier.
Example 3 — Dividends (4 marks)
The company has 500,000 ordinary shares of $1 and 100,000 8% preference shares of $1. The directors declare an ordinary dividend of 6 cents per share.
Preference dividend = 8% × $100,000 = $8,000. Ordinary dividend = 500,000 × $0.06 = $30,000. Total distribution = $38,000.
The preference dividend is paid first and does not vary. Neither is an expense — both are distributions of profit, and they reduce retained earnings.
Example 4 — Subscriptions income (5 marks)
A sports club received $84,000 in subscriptions during the year. Subscriptions owing were $3,000 at the start and $4,500 at the end. Subscriptions received in advance were $2,000 at the start and $1,500 at the end.
Income = $84,000 − $3,000 + $4,500 + $2,000 − $1,500.
Working: $84,000 − $3,000 = $81,000; + $4,500 = $85,500; + $2,000 = $87,500; − $1,500 = $86,000.
Reasoning for each step: the $3,000 collected this year was last year's income; the $4,500 still owing is this year's income even though unpaid; the $2,000 held in advance at the start belongs to this year; the $1,500 held in advance now belongs to next year.
Example 5 — Accumulated fund (4 marks)
At the start of the year a club held: clubhouse $240,000, equipment $36,000, bank $14,000, subscriptions owing $3,000; and owed creditors $9,000 and subscriptions in advance $2,000.
Assets = $240,000 + $36,000 + $14,000 + $3,000 = $293,000. Liabilities = $9,000 + $2,000 = $11,000. Accumulated fund = $293,000 − $11,000 = $282,000.
Common mistakes and how to avoid them
Merging share premium into share capital. They are separate, and only one is distributable.
Treating dividends as an expense. They are a distribution of profit, like drawings.
Saying a bonus issue raises cash. It raises no cash; a rights issue does.
Calling a non-profit organisation's result a profit. It is a surplus or a deficit.
Presenting a receipts and payments account as though it were an income and expenditure account. The first is cash and mixes capital with revenue; the second is accruals-based and revenue only.
Getting the subscriptions adjustment backwards. Work each item from first principles: does this amount belong to this year's income or not?
Forgetting to charge depreciation in the income and expenditure account. It is a revenue expense like any other and is routinely omitted.
How this links to your Internal Assessment
A club, church group or community association is often a more practical Internal Assessment subject than a business, because the treasurer's records are accessible and the membership is willing to talk about them. If you take one, convert its receipts and payments account into a proper income and expenditure account and say explicitly what the conversion revealed — the depreciation never charged, the subscriptions in arrears never recognised, the capital purchase treated as a running cost.
That conversion is itself the analysis. A treasurer reporting only cash cannot tell the members whether the organisation lived within its means, and demonstrating the difference with the organisation's own figures is a stronger finding than any general comment about record-keeping.
If your subject is a company, focus on something a company uniquely offers: the dividend decision. Set out what was distributed against what was earned and what the company retained for reinvestment, and assess whether the balance suits its stage of growth.
Exam technique for company and non-profit accounts
Questions split into two types and the vocabulary is where marks are quietly lost. For companies, never write drawings or capital; write dividends and share capital. For non-profit organisations, never write profit or capital; write surplus, deficit and accumulated fund.
Subscription questions almost always require a working, so set one out as a short T account or a labelled calculation. The examiner cannot award method marks for a single figure with no derivation behind it.
Watch the command words. Calculate the accumulated fund means show assets, liabilities and the subtraction. Distinguish between a bonus issue and a rights issue wants the contrast drawn on both cash and ownership. Explain why a share premium cannot be distributed wants the creditor-protection reason, not a restatement of the rule. Evaluate a dividend policy wants both the shareholder's interest in income and the company's need to retain funds, and then a conclusion.
If asked to prepare an income and expenditure account from a receipts and payments account, work down the receipts and payments line by line and label each item as capital or revenue before you start. Most errors in this question are items placed in the wrong statement, not arithmetic.
Quick revision summary
- A company is a separate legal person; shareholders have limited liability.
- Share capital is nominal value; anything above it is share premium, a non-distributable reserve.
- Retained earnings are the main distributable reserve; share premium and revaluation reserve are not.
- Preference dividends are fixed and paid first; ordinary dividends vary and are paid after.
- Dividends are distributions of profit, never expenses.
- Bonus issue: free shares, reserves capitalised, no cash, total equity unchanged.
- Rights issue: shares offered to existing holders at a discount, cash received, equity increased.
- Non-profit: accumulated fund not capital, surplus or deficit not profit.
- Receipts and payments is cash only and mixes capital with revenue; income and expenditure is accruals-based and revenue only.
- Subscriptions: cash received, less opening arrears, plus closing arrears, plus opening advances, less closing advances.
- Accumulated fund = assets less liabilities at the start of the year.