What you'll learn
This guide covers the preparation and presentation of financial statements for limited companies as required by Pearson Edexcel International IGCSE Accounting. You will learn how company accounts differ from sole trader accounts, understand the treatment of share capital and reserves, and prepare income statements and statements of financial position in the prescribed format.
Key terms and definitions
Limited company — a business organisation owned by shareholders with liability limited to the amount they have invested in shares
Ordinary shares — shares that give owners voting rights and a claim to dividends when declared by directors
Share capital — the nominal (face) value of shares issued to shareholders, representing permanent capital invested in the company
Revenue reserves — profits retained in the business that can be distributed to shareholders as dividends (e.g., retained earnings)
Capital reserves — reserves that cannot be distributed as dividends, created from capital transactions (e.g., share premium, revaluation reserve)
Dividend — a distribution of profits to shareholders, usually expressed as an amount per share
Appropriation account — the section of the income statement showing how profit after tax is distributed between dividends and retained earnings
Statement of financial position — a financial statement showing assets, liabilities, and equity of a company at a specific date (previously called the balance sheet)
Core concepts
Differences between sole trader and company accounts
Limited companies prepare financial statements differently from sole traders due to their legal status and ownership structure:
Ownership structure:
- Companies are owned by shareholders, not a single proprietor
- Shareholders appoint directors to manage the business
- Profits belong to the company, not directly to owners
Capital section:
- Companies show share capital rather than a capital account
- Reserves (both revenue and capital) replace drawings
- Equity comprises share capital plus reserves
Profit distribution:
- Companies pay corporation tax on profits
- Remaining profits may be distributed as dividends or retained
- Dividends require director approval and cannot exceed distributable reserves
Legal requirements:
- Companies must follow International Accounting Standards (IAS) format
- Greater disclosure requirements than sole traders
- Audited accounts required for most companies
Share capital and reserves
The equity section of a company's statement of financial position consists of share capital and reserves.
Share capital components:
- Authorised share capital: maximum value of shares the company can issue
- Issued share capital: nominal value of shares actually issued to shareholders
- Called-up share capital: amount shareholders must pay (may be less than nominal if partly-paid shares exist)
Capital reserves (non-distributable):
- Share premium: amount received above nominal value when shares issued
- Revaluation reserve: gains from revaluing non-current assets upwards
- Cannot be paid out as dividends
- Can only be used for specific purposes (e.g., bonus share issues)
Revenue reserves (distributable):
- Retained earnings: accumulated profits not distributed as dividends
- General reserve: amounts transferred from retained earnings for future use
- Can be distributed to shareholders as dividends
Movements in reserves:
- Revenue reserves increase through profit retention
- Revenue reserves decrease through dividend payments or losses
- Capital reserves typically only increase (reductions are rare and restricted)
The income statement (profit and loss account)
The company income statement follows a vertical format and includes additional items compared to sole trader accounts.
Standard structure:
Trading section:
- Revenue (sales)
- Less: Cost of sales
- = Gross profit
Profit or loss section:
- Gross profit
- Add: Other income
- Less: Operating expenses (distribution costs, administrative expenses)
- = Profit from operations
Finance costs:
- Profit from operations
- Less: Finance costs (loan interest, debenture interest)
- = Profit before tax
Taxation:
- Profit before tax
- Less: Corporation tax
- = Profit for the year
Appropriation section:
- Profit for the year
- Less: Dividends (interim and final)
- = Retained profit for the year
- Add: Retained earnings brought forward
- = Retained earnings carried forward
Key points:
- Dividends are appropriations of profit, not expenses
- Corporation tax is charged on company profits
- Directors' remuneration is an expense, not an appropriation
- Debenture interest is an expense (finance cost), not an appropriation
The statement of financial position
Company statements of financial position present assets, liabilities, and equity in a prescribed format.
Standard format:
Non-current assets:
- Property, plant and equipment (at carrying amount)
- Intangible assets
Current assets:
- Inventories
- Trade receivables
- Cash and cash equivalents
Total assets
Equity:
- Share capital
- Share premium
- Revaluation reserve
- Retained earnings
- = Total equity
Non-current liabilities:
- Long-term loans
- Debentures
Current liabilities:
- Trade payables
- Tax payable
- Dividends payable
- Bank overdraft
Total equity and liabilities
Important notes:
- Assets = Equity + Liabilities (accounting equation)
- Proposed dividends appear as current liabilities until paid
- Corporation tax payable is a current liability
- Share premium appears immediately after share capital
Dividends and their treatment
Dividends represent the distribution of profits to shareholders and require careful accounting treatment.
Types of dividends:
Interim dividend:
- Paid during the financial year
- Based on half-year results
- Declared by directors without shareholder approval
Final dividend:
- Proposed after year-end
- Requires shareholder approval at AGM
- Based on full-year results
Accounting treatment:
At year-end:
- Interim dividend paid: reduces retained earnings (already deducted from bank)
- Final dividend proposed: shown as current liability and deducted in appropriation account
In income statement:
- Both interim and final dividends deducted from profit for the year
- Shown in appropriation section, not as expenses
In statement of financial position:
- Interim dividend: already paid, no liability shown
- Final dividend: appears as current liability (dividends payable)
Calculation example:
- 100,000 ordinary shares of £1 each
- Interim dividend of 5p per share = £5,000
- Final dividend of 8p per share = £8,000
- Total dividends = £13,000
Bonus issues and rights issues
Companies can issue additional shares in different ways, each affecting the financial statements differently.
Bonus issue (scrip issue):
- Free shares given to existing shareholders
- Funded from reserves (usually share premium or revaluation reserve)
- No cash received by company
- Reduces reserves, increases share capital
- Total equity unchanged
Rights issue:
- Existing shareholders offered new shares at favorable price
- Usually below market price but above nominal value
- Cash received increases assets and equity
- Creates share premium if issued above nominal value
Impact on financial statements:
Bonus issue of 50,000 £1 shares using share premium:
- Dr Share premium £50,000
- Cr Share capital £50,000
Rights issue of 50,000 £1 shares at £1.20:
- Dr Bank £60,000
- Cr Share capital £50,000
- Cr Share premium £10,000
Worked examples
Example 1: Income statement preparation
Greenfield Ltd has the following information for the year ended 31 December 2023:
- Revenue: £450,000
- Opening inventory: £35,000
- Purchases: £280,000
- Closing inventory: £40,000
- Distribution costs: £42,000
- Administrative expenses: £68,000
- Debenture interest: £6,000
- Corporation tax: £18,000
- Interim dividend paid: £5,000
- Final dividend proposed: £10,000
- Retained earnings at 1 January 2023: £95,000
Required: Prepare the income statement for the year ended 31 December 2023.
Solution:
Greenfield Ltd Income Statement for the year ended 31 December 2023
| £ | £ | |
|---|---|---|
| Revenue | 450,000 | |
| Cost of sales: | ||
| Opening inventory | 35,000 | |
| Purchases | 280,000 | |
| 315,000 | ||
| Less: Closing inventory | (40,000) | (275,000) |
| Gross profit | 175,000 | |
| Distribution costs | (42,000) | |
| Administrative expenses | (68,000) | (110,000) |
| Profit from operations | 65,000 | |
| Finance costs: Debenture interest | (6,000) | |
| Profit before tax | 59,000 | |
| Corporation tax | (18,000) | |
| Profit for the year | 41,000 | |
| Interim dividend | (5,000) | |
| Final dividend | (10,000) | (15,000) |
| Retained profit for the year | 26,000 | |
| Retained earnings brought forward | 95,000 | |
| Retained earnings carried forward | 121,000 |
Example 2: Statement of financial position (equity section)
Riverside Ltd has the following balances at 31 March 2024:
- Issued share capital: 200,000 ordinary shares of 50p each
- Share premium account: £30,000
- Revaluation reserve: £15,000
- Retained earnings: £87,000
- 8% Debentures: £50,000
- Trade payables: £42,000
- Final dividend proposed: £16,000
- Corporation tax payable: £12,000
Required: Prepare the equity and liabilities section of the statement of financial position.
Solution:
Riverside Ltd Statement of Financial Position (extract) as at 31 March 2024
| £ | £ | |
|---|---|---|
| EQUITY | ||
| Share capital (200,000 × £0.50) | 100,000 | |
| Share premium | 30,000 | |
| Revaluation reserve | 15,000 | |
| Retained earnings | 87,000 | |
| Total equity | 232,000 | |
| NON-CURRENT LIABILITIES | ||
| 8% Debentures | 50,000 | |
| CURRENT LIABILITIES | ||
| Trade payables | 42,000 | |
| Dividends payable | 16,000 | |
| Tax payable | 12,000 | 70,000 |
| Total equity and liabilities | 352,000 |
Example 3: Share issues
Morgan Ltd has issued share capital of 400,000 ordinary shares of £1 each and share premium of £80,000.
On 1 July 2024, the company:
- Made a bonus issue of 1 share for every 4 held, using the share premium account
- Made a rights issue of 1 share for every 5 held at £1.30 per share
Required: Calculate the new balances for share capital and share premium.
Solution:
Bonus issue:
- Shares issued: 400,000 ÷ 4 = 100,000 shares
- Value: 100,000 × £1 = £100,000
- Dr Share premium £100,000
- Cr Share capital £100,000
After bonus issue:
- Share capital: £400,000 + £100,000 = £500,000
- Share premium: £80,000 - £100,000 = (£20,000) — Impossible!
Correction: Only £80,000 available in share premium, so only 80,000 bonus shares can be issued.
Rights issue:
- Shares now in issue: 400,000 + 80,000 = 480,000
- Rights shares: 480,000 ÷ 5 = 96,000 shares
- Cash received: 96,000 × £1.30 = £124,800
- Share capital increase: 96,000 × £1 = £96,000
- Share premium increase: 96,000 × £0.30 = £28,800
Final balances:
- Share capital: £400,000 + £80,000 + £96,000 = £576,000
- Share premium: £80,000 - £80,000 + £28,800 = £28,800
Common mistakes and how to avoid them
Treating dividends as expenses: Dividends are appropriations of profit, shown after profit for the year, not deducted before calculating profit. Include them in the appropriation section only.
Confusing capital and revenue reserves: Remember that share premium and revaluation reserves cannot be distributed as dividends. Only revenue reserves (retained earnings, general reserve) are distributable.
Incorrect treatment of proposed dividends: Final dividends proposed but not paid must appear both in the appropriation account (deducted from profit) and as a current liability in the statement of financial position.
Misclassifying debenture interest: Debenture interest is a finance cost (expense), not an appropriation. Deduct it before arriving at profit before tax, not after.
Ignoring the share premium on rights issues: When shares are issued above nominal value, split the proceeds between share capital (nominal value) and share premium (excess). Calculate carefully using the number of shares and price per share.
Presenting the statement of financial position incorrectly: Follow the required format: non-current assets, current assets, total assets, then equity, non-current liabilities, current liabilities. Assets must equal equity plus liabilities.
Exam technique for "Financial Statements: Company Accounts"
Understand command words: "Prepare" requires a full statement with correct headings, dates, and format. "Calculate" needs workings shown. "State" requires a brief definition without explanation.
Use correct statement headings: Include company name, statement type, and period/date. For income statements: "for the year ended [date]". For statements of financial position: "as at [date]". Incorrect headings lose presentation marks.
Show clear workings: Examiners award method marks even if final answers are wrong. Show cost of sales calculations, dividend calculations, and reserve movements separately. Label each working clearly.
Allocate time by marks: Spend approximately 1.5 minutes per mark. A 20-mark income statement question deserves 30 minutes. Don't spend excessive time perfecting one section while neglecting others.
Quick revision summary
Company accounts differ from sole trader accounts through their capital structure (share capital and reserves), profit distribution (dividends and corporation tax), and presentation format. The income statement shows profit calculation through to appropriation, deducting corporation tax and dividends. The statement of financial position presents equity as share capital plus reserves (both capital and revenue). Capital reserves cannot be distributed as dividends. Proposed dividends appear as current liabilities. Bonus issues reduce reserves without changing total equity; rights issues increase both cash and equity.