Accounting for Limited Companies

CIMA-BA3 · Chapter 16

Accounting for Limited Companies

A limited company records its transactions exactly as a sole trader does; what changes is the presentation. The company pays its own tax (an expense), the owners’ interest is shown as share capital plus reserves, and the money paid to shareholders is a dividend, which is never an expense. Shares are recorded at their nominal value in share capital, with any extra in share premium. A rights issue raises cash; a bonus issue gives free shares and is funded from reserves, usually share premium. Retained earnings are a revenue reserve and can be paid as dividends; share premium and the revaluation reserve are capital reserves and cannot. Every change in equity is explained in the statement of changes in equity.

1 Introduction

Most of our examples so far have related to sole traders. In this chapter we will consider limited companies.

All the day to day double entries are as we have covered, but there are various differences that we need to consider in terms of the layout of the financial statements and the terminology.

2 The key features of a limited company

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A limited company is a separate legal entity
For a sole trader the business and the owner are separate only for accounting purposes; in law they are the same person. A company is registered and exists separately in law: it owns its assets, owes its debts, can sue and be sued, and pays tax on its own profits.
The owners of the company (shareholders) are separate from the management (directors)
The shareholders own the company and the profits belong to them; they receive dividends, the company’s equivalent of drawings. The directors run the company and are employees: their salaries are an expense, even when a director is also a shareholder.
The shareholders have limited liability for the debts of the company
If the company fails, owing more than it owns, a shareholder can lose the money invested in the shares but no more. The company itself remains liable for all its debts.
There are more formalities required (e.g. disclosure, audit)
Because the people a company deals with cannot look to the shareholders for payment, company law (legislation) requires a company to keep accounting records, to prepare annual financial statements in the formats set by accounting standards (IAS 1), to make them available to shareholders and file them with the state where anyone can read them and, for most companies, to have them audited.

3 The layout of Financial Statements

The layout of the financial statements is very similar to that of a sole trader. There are however a few important differences:

the capital will be shown differently in the Statement of Financial Position
for internal management use the company will prepare a detailed Statement of Profit or Loss, exactly as for a sole trader, but the version published for shareholders and the public is summarised. The financial statements of a limited company are available to the general public, so only the summarised format has to be made available.
the financial statements will also include a ‘Statement of Changes in Equity’ in order to inform shareholders as to why the equity balances have changed over the year.
because a limited company is a separate legal entity, the company itself will pay tax which will therefore appear as an expense in the Statement of Profit or Loss, and (if owing at the year end) will appear as a current liability in the Statement of Financial Position.

We will look at these statements and the differences as we work through this chapter.

Note that a limited company will normally also be required to produce a Statement of Cash Flows. We will deal with this in a separate chapter (Chapter 17).

Note also that in practice the financial statements will always show last year’s figures as well (comparative figures). However, you will never be required to show these in examinations.

4 The Statement of Profit or Loss

As written in the previous section, a limited company will usually prepare a detailed Statement of Profit or Loss as for a sole trader, showing all of the separate expenses - this will be used for management purposes. They will then produce a ‘summarised’ version which will be filed with the State and will be sent to the shareholders. The standard format is as in the statement below.

Statement of Profit or Loss for the year ended 31 December 2016

	$
Revenue	100,000
Cost of sales	(40,000)
Gross profit	60,000
Other income	2,000
	62,000
Distribution costs	(26,000)
Administrative expenses	(9,000)
Operating profit	27,000
Finance costs (interest)	(2,000)
Profit before tax	25,000
Income tax expense	(5,000)
Profit for the year	20,000

The expenses are not listed one by one; they are grouped under a few headings, and two items are always shown separately, in this order, after operating profit: finance costs and tax.

Heading	What goes in it
Cost of sales	Opening inventory + purchases − closing inventory (the workings are not shown)
Distribution costs	The costs of selling and delivering the goods: delivery drivers’ wages, depreciation of delivery vans, salespeople’s salaries, the rent of the sales offices
Administrative expenses	The costs of running the business: wages of the accounts department and reception, depreciation of office computers, rent and electricity of the administrative offices, directors’ salaries
Operating profit	The profit from the business’s operations, before finance costs and tax ($27,000 above)
Finance costs	Interest on loans and overdrafts
Income tax expense	The tax on the company’s profit for the year (often called corporation tax). You will not be asked to calculate it. It is the charge for the year whether or not it has been paid; any amount still owing at the year end is a current liability.

Dividends do not appear in the statement of profit or loss. Like a sole trader’s drawings, they are a payment to the owners, not an expense.

5 The Statement of Financial Position

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The Statement of Financial Position is almost identical to that for a sole trader.

The assets are presented in exactly the same way, with the exception that only the carrying amount (cost less accumulated depreciation) is shown on the face of the Statement. Details of the cost and accumulated depreciation (and the movements on non-current assets) are shown in a separate statement.

The main difference is the presentation of the amount owing to the owners (equivalent to the capital in the case of a sole trader) as you can see in the example below:

	$	$
ASSETS
Non-current assets
Property, plant and equipment	100,000
Motor vehicles	20,000
		120,000
Current assets
Inventories	5,000
Trade receivables	8,000
Prepayments	500
Cash	1,500
		15,000
Total assets		135,000
EQUITY AND LIABILITIES
Capital and reserves
Share capital	50,000
Capital reserves	15,000
Revenue reserves	42,000
		107,000
Non-current liabilities
10% Loan notes	20,000
		20,000
Current liabilities
Trade and other payables	2,000
Tax payable	4,000
Short-term borrowings	2,000
		8,000
Total equity and liabilities		135,000

Here the capital reserves of $15,000 are the share premium ($10,000) and the revaluation reserve ($5,000), and the revenue reserves of $42,000 are the retained earnings — sections 8 to 11 explain each one, and the statement of changes in equity in section 14 shows how they reached these figures. The tax payable of $4,000 is the part of the year’s tax charge still owing. The 10% on the loan notes is the rate of interest; the loan notes are repayable more than twelve months after the year end, so they are a non-current liability.

The lectures sometimes use older names for the carrying amount, such as ‘carrying value’; the notes use carrying amount. The lectures also sometimes say pounds — read every amount as dollars.

6 Capital on the Statement of Financial Position

When a sole trader puts money into the business it is known as Capital. With a limited company, many shareholders will put money into the business, and it is known as Share Capital (we will deal with the issuing of shares shortly).

As a sole trader makes profits and takes drawings, the Capital will change from year to year.

For a limited company, the money taken by shareholders is called Dividends (not drawings). The amount remaining owing to shareholders will be the share capital plus the profits less the dividends, but the presentation is different - the share capital remains unchanged, and the profits less dividends are shown separately as Retained Earnings.

Alex is a sole trader, and Bertha Ltd is a limited company.

They both start business with capital of $10,000.

They both make profits in the first three years of trading, and Alex takes drawings, and Bertha pays dividends, of the same amount each year as follows:

	Profit $	Drawings / dividends $
Year 1	5,000	1,000
Year 2	7,000	2,000
Year 3	10,000	3,000

You are required to show how the capital section of the Statement of Financial Position would appear at the end of each of the three years, for each business.

Alex — sole trader

	Year 1 $	Year 2 $	Year 3 $
Capital brought forward	10,000	14,000	19,000
Profit for the year	5,000	7,000	10,000
Less: drawings	(1,000)	(2,000)	(3,000)
Capital carried forward	14,000	19,000	26,000

Bertha Ltd — limited company

	Year 1 $	Year 2 $	Year 3 $
Share capital	10,000	10,000	10,000
Retained earnings	4,000	9,000	16,000
Total equity	14,000	19,000	26,000

Retained earnings (working): Year 1 5,000 − 1,000 = 4,000; Year 2 4,000 + 7,000 − 2,000 = 9,000; Year 3 9,000 + 10,000 − 3,000 = 16,000.

The total owed to the owners is the same for both businesses each year. The difference is presentation: the company’s share capital stays at $10,000 unless more shares are issued, and all the profits the company has made since it started, less all the dividends recorded so far, are shown as one figure — retained earnings. A dividend is recorded when it has been properly approved and can no longer be cancelled, whether or not it has yet been paid (section 7); here each year’s dividend was approved and paid in the same year. The working is not shown on the face of the statement.

7 Dividends

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For ordinary shareholders (equity), the directors of the company will propose a dividend payable to shareholders which will largely depend on how much profit the business has made - the shareholders will then vote on it at the annual general meeting of the company. Because the directors will not be in a position to decide on the dividend to propose until the end of the year when they know what the profits are, the proposed dividend will normally not be paid to the shareholders until early in the following year.

A dividend is recorded when the company becomes obliged to pay it: when it has been properly approved and can no longer be cancelled. For a final dividend this is normally when the shareholders approve it at the annual general meeting. A dividend that the directors have only proposed is not yet an obligation, so a proposed dividend does not appear in the Statement of Financial Position, and it is not subtracted from the retained earnings until the year in which it is approved.

Instead of shareholders having to wait a whole year for each dividend, it is common for companies to pay a small dividend during the year - this is known as an Interim Dividend - and then propose a Final Dividend at the end of the year when they know what profit has been made.

So a dividend passes through three separate steps, and only the second one changes retained earnings:

Step	What it means	Effect in the financial statements
Proposed	The directors suggest a dividend. The shareholders have not yet approved it, and it could still be changed or cancelled.	No entry and no liability. A final dividend proposed at the year end is disclosed in a note.
Approved (declared)	The dividend has been properly authorised, and the company can no longer avoid paying it.	Dr Retained earnings, Cr Dividends payable (a current liability). Deducted from retained earnings in the statement of changes in equity.
Paid	The cash is paid to the shareholders.	Dr Dividends payable, Cr Cash. Retained earnings do not change again.

Which year’s profit a dividend comes from does not matter: it is deducted from retained earnings in the year it is approved. A final dividend is usually approved and paid early in the following year, and an interim dividend is normally recorded when it is paid (until then the directors can usually still change it), so in practice most dividends are recorded in the year they are paid. But it is the approval, not the payment, that counts. If the shareholders approve a dividend of $6,000 on 15 December and it is paid on 20 January, retained earnings at 31 December are reduced by $6,000 and dividends payable of $6,000 are shown as a current liability; the cash goes out only in January.

A dividend never appears in the statement of profit or loss; it is deducted from retained earnings in the statement of changes in equity. Chapter 26 explains why a dividend declared after the year end is not a liability at the year end.

A company has a year end of 31 December each year.

During the year ended 31 December 2017, the following occurred:

Date	Event
1 March 2017	Paid a final dividend for year ended 31.12.2016 of $5,000
5 July 2017	Paid an interim dividend for year ended 31.12.2017 of $1,000
31 December 2017	Proposed a final dividend of year ended 31.12.2017 of $6,000

State the effect of each of these dividends in the financial statements of the company for the year to 31 December 2017.

Dividend	Effect in the 2017 financial statements
Final dividend for 2016, paid 1 March 2017, $5,000	Recorded in 2017. At 31 December 2016 it was only proposed, so it was not a liability then; it was approved and paid in 2017: Dr Retained earnings, Cr Cash. Deducted from retained earnings in the statement of changes in equity.
Interim dividend for 2017, paid 5 July 2017, $1,000	Recorded in 2017, when it was paid: deducted from retained earnings in the same way.
Final dividend for 2017, proposed 31 December 2017, $6,000	Not recorded in 2017. At the year end it is only a proposal: the shareholders have not approved it, so there is no liability. It is disclosed in a note, and will be deducted from retained earnings in 2018, when the shareholders approve it.

Statement of profit or loss: no dividends at all. Statement of financial position: no dividend appears as a separate item, because nothing is owed to the shareholders at the year end, but retained earnings are reduced by the dividends recorded in the year, 5,000 + 1,000 = $6,000. Statement of changes in equity: dividends paid $6,000.

In the lecture the tutor says that dividends are recorded only when they are actually paid. That gives the right answers for Example 2, because each dividend there is approved and paid in the same year. The rule itself is that a dividend is recorded when it is approved and can no longer be cancelled: a dividend approved before the year end but not paid until after it is a liability (dividends payable) at the year end.

8 Reserves

A reserve is anything owing to shareholders in addition to the Share Capital.

We have seen one reason for a reserve to exist - retained earnings.

This is known as a Revenue Reserve, because the company is allowed (should they wish) to pay it to shareholders as dividend - it is distributable.

There are two other reasons why a reserve may exist - one (the Share Premium Account) can occur when shares are issued, the other (the Revaluation Reserve) if any non-current assets are revalued. As you will see in the following paragraphs, these are known as Capital Reserves because they cannot be distributed to shareholders as dividends.

Reserve	How it arises	Type	Can it be paid as a dividend?
Retained earnings	Profits since the company started, less the dividends recorded (sections 6 and 7)	Revenue reserve	Yes — distributable
Share premium	Shares issued for more than their nominal value (section 9)	Capital reserve	No
Revaluation reserve (revaluation surplus)	Non-current assets revalued upwards (section 11)	Capital reserve	No

For example, if a company has share capital of $20,000 and retained earnings of $10,000, the shareholders are owed $30,000 in total, but the most the company could legally pay as a dividend is the $10,000 of retained earnings. Share capital is repaid only if the company is closed down and all its liabilities have been paid.

9 The issue of shares

A company can issue shares at any price it wants, provided that it is not less than the nominal value (also called the par value: the amount printed on the shares and stated in the statutes of the company).

If shares are issued at a price higher than the nominal value, then the extra is known as share premium.

The total raised is effectively the capital, but it is shown as two separate items on the Statement of Financial Position – share capital (the nominal amount) and share premium (the excess). The Share Premium Account is a capital reserve - it cannot be distributed to shareholders by way of dividend.

The entry for an issue of shares for cash is therefore:

Account	Debit $	Credit $
Dr Cash (number of shares × issue price)	x
Cr Share capital (number of shares × nominal value)		x
Cr Share premium (number of shares × (issue price − nominal value))		x

A company is formed on 1 January 2015 and issues 10,000 $0.50 shares at a price of $0.50 each.
Show the necessary entries to record this transaction, and what will appear in the Statement of Financial Position under the heading equity.
The same company issued more shares on 30 June 2017. It issues another 20,000 $0.50 shares at a price of $0.80 each.
Show the necessary entries to record this transaction, and what will now appear in the Statement of Financial Position.

(a) Cash received = 10,000 × $0.50 = $5,000. The shares are issued at their nominal value, so there is no premium.

Account	Debit $	Credit $
Dr Cash	5,000
Cr Share capital		5,000

Equity	$
Share capital (10,000 shares of $0.50)	5,000

(b) Cash received = 20,000 × $0.80 = $16,000. Share capital is credited with the nominal value, 20,000 × $0.50 = $10,000; the premium of $0.30 a share, 20,000 × $0.30 = $6,000, is credited to share premium.

Account	Debit $	Credit $
Dr Cash	16,000
Cr Share capital		10,000
Cr Share premium		6,000

Equity	$
Share capital (30,000 shares of $0.50)	15,000
Share premium	6,000
	21,000

The shareholders have paid in 5,000 + 16,000 = $21,000 in total, split between share capital (the nominal value of all 30,000 shares) and share premium. Retained earnings would also appear under equity, but they are not given here.

10 Rights issues and Bonus issues of shares

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A Rights Issue is an offer of new shares in the company to existing shareholders.

The shares must be offered to all existing shareholders in the same ratio, depending on how many shares they currently own.

(Shareholders do not have to buy the new shares, but in the exam we do assume that they do so - that the issue is fully subscribed.)

A Bonus Issue is the issue of new shares to existing shareholders, free of charge.

Again, they must be given to existing shareholders in the same ratio.

The ratio is always expressed as, for example, ‘1 for 5’: one new share for every five already held. In both cases the new shares have the same nominal value as the existing shares.

Since new shares are issued, the Share Capital must increase. However, because shareholders did not pay in any cash, the total owing to shareholders will not change and therefore Reserves must fall by the same amount as the increase in the Share Capital. Companies are allowed to use the Share Premium Account for this purpose, and will always use this account in preference.

	Rights issue	Bonus issue
Cash received?	Yes — the shareholders pay the issue price	No — the shares are free
Entry	Dr Cash; Cr Share capital (nominal value); Cr Share premium (any excess)	Dr Share premium (or another reserve if there is not enough share premium); Cr Share capital (nominal value)
Effect on total equity	Increases by the cash received	No change — one part of equity moves to another

(Companies have bonus issues partly as a way of ‘tidying up’ their Financial Statements by removing the Share Premium Account, but mainly as a way of reducing the share price on the Stock Exchange - however understanding this is not in the syllabus for this exam.)

At 31 December 2004 a company’s capital structure was as follows:

	$
Ordinary share capital (500,000 shares of 25c each)	125,000
Share premium account	100,000

During the year ended 31 December 2005, the company made a rights issue of 1 share for every 2 held at $1 per share and this was taken up in full. Later in the year, the company made a bonus issue of 1 share for every 5 held, using the share premium account for the purpose.

What would the balances be on the share capital and share premium accounts at 31 December 2005?

	Number of shares	Share capital $	Share premium $
Balance at 1 January 2005	500,000	125,000	100,000
Rights issue 1 for 2 at $1 (250,000 shares; premium $0.75 each)	250,000	62,500	187,500
	750,000	187,500	287,500
Bonus issue 1 for 5 (150,000 shares at 25c)	150,000	37,500	(37,500)
Balance at 31 December 2005	900,000	225,000	250,000

The rights issue raises 250,000 × $1 = $250,000 in cash: $62,500 nominal value (250,000 × $0.25) to share capital and $187,500 premium (250,000 × $0.75) to share premium. The bonus issue is based on the 750,000 shares held after the rights issue: 750,000 ÷ 5 = 150,000 new shares, nominal value 150,000 × $0.25 = $37,500, Dr Share premium, Cr Share capital.

At 31 December 2005 share capital is $225,000 and share premium is $250,000, a total of $475,000. The bonus issue did not change that total. Retained earnings are not affected by either issue.

11 The Revaluation Reserve

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During a period of high-inflation, the value of non-current assets may be well in excess of their carrying amount.

In this situation a company may choose to show the current worth of such assets on their Statement of Financial Position.

Any profit resulting from such revaluation is an unrealised profit (in that the asset has not been sold and therefore no real profit has actually been made). As a result, the profit is shown separately from the Statement of Profit or Loss in a revaluation reserve. (For a limited company this must be the case. For a sole trader, where the owner has unlimited liability, this is not a rule even though it is good practice.)

IAS 16 Property, Plant and Equipment requires that when an item of property, plant or equipment is revalued, then the entire class of property, plant and equipment to which the asset belongs must be revalued.

When a non-current asset has been revalued, the future charge for depreciation should be based on the revalued amount and the remaining economic life of the asset.

The depreciation charge will be higher than it was before the revaluation. IAS 16 allows (but does not require) the excess of the new charge over the old charge to be transferred each year from the revaluation reserve to retained earnings; where the transfer is made it is shown in the statement of changes in equity, not in profit or loss. The revaluation reserve is also called the revaluation surplus.

Purpurs has a year end of 31 December each year.

In his Statement of Financial Position as at 31 December 2002 he has buildings at a cost of $3,600,000 and accumulated depreciation of $1,080,000.

His depreciation policy is to charge 2% straight line.

On 30 June 2003, the building is to be revalued at $3,072,000. There is no change in the remaining estimated useful life of the building.

Show the relevant ledger accounts for the year to 31 December 2003.

This is the same example as Example 5 in Chapter 5, and the answer is the same.

Workings

(W1) Depreciation 1 January to 30 June 2003 (on cost) = 6/12 × 2% × $3,600,000 = $36,000.

Accumulated depreciation at 30 June 2003 = $1,080,000 + $36,000 = $1,116,000. Carrying amount = $3,600,000 – $1,116,000 = $2,484,000.

Revaluation surplus = $3,072,000 – $2,484,000 = $588,000.

Remaining life: at 2% a year the building’s total life is 100 ÷ 2 = 50 years. The depreciation so far is $1,116,000 ÷ $72,000 a year = 15.5 years, so 50 – 15.5 = 34.5 years remain.

(W2) Depreciation 1 July to 31 December 2003 (on the valuation) = 6/12 × $3,072,000 ÷ 34.5 = $44,522 (to the nearest dollar). Total depreciation expense for 2003 = $36,000 + $44,522 = $80,522.

(W3) Excess depreciation transferred to retained earnings = $44,522 – 6/12 × $72,000 = $44,522 – $36,000 = $8,522 (equivalently 6/12 × $588,000 ÷ 34.5).

Debit	Buildings		Credit
Balance	3,600,000	Revaluation surplus	528,000
		Balance	3,072,000
	3,600,000		3,600,000
Balance (valuation)	3,072,000

Debit	Accumulated depreciation – buildings		Credit
30.6.2003 Revaluation surplus	1,116,000	1.1.2003 Balance	1,080,000
		30.6.2003 Depreciation expense (W1)	36,000
	1,116,000		1,116,000
		31.12.2003 Depreciation expense (W2)	44,522

The accumulated depreciation is cleared to nil on revaluation; the credit balance at 31 December 2003 is the $44,522 charged since.

Debit	Depreciation expense		Credit
Accumulated depreciation (W1)	36,000	Statement of profit or loss	80,522
Accumulated depreciation (W2)	44,522
	80,522		80,522

Debit	Revaluation surplus		Credit
Buildings	528,000	Accumulated depreciation	1,116,000
Retained earnings (W3)	8,522
Balance	579,478
	1,116,000		1,116,000
		Balance	579,478

Debit	Retained earnings (extract)		Credit
		Revaluation surplus (W3)	8,522

At 31 December 2003 the building is shown at its valuation of $3,072,000 less accumulated depreciation of $44,522 = carrying amount $3,027,478, and the revaluation surplus in equity is $588,000 – $8,522 = $579,478. The $588,000 gain is other comprehensive income for 2003; it is not in the profit for the year.

The lecture works this example as far as the revaluation surplus of $588,000. The answer above also shows the depreciation for the rest of 2003 and the transfer to retained earnings.

A company’s equity is: share capital $20,000; share premium $20,000; retained earnings $90,000; revaluation reserve $50,000.

The total owed to the shareholders is 20,000 + 20,000 + 90,000 + 50,000 = $170,000. The maximum dividend the company could legally pay is the revenue reserve only — the retained earnings of $90,000. Share capital cannot be paid out as a dividend, and share premium and the revaluation reserve are capital reserves.

At the end of the revaluation lecture the tutor asks this same question and gives the maximum dividend as $20,000. That is a slip: the maximum is the retained earnings, $90,000.

12 Preference Shares

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All the shares that we have referred to so far in this chapter have been what are known as ordinary shares (or equity shares). All limited companies must have ordinary shareholders - these shareholders are entitled to vote at meetings, and the dividends they receive are not certain, they depend largely on the level of profit that the company has made.

Some companies have in addition what are known as preference shares. These shares receive a fixed dividend each year that has to be paid to them, and the ordinary shareholders are only entitled to their dividends out of whatever profits are left after paying the preference dividends.

A company has in issue 10,000 5% Preference Shares of $1 each. The dividend is payable half-yearly.

How much dividend will the company pay each time?

The dividend rate is applied to the nominal value: 5% × $1 = 5 cents a share a year. Paid half-yearly, that is 2.5 cents a share each time.

Each payment = 10,000 shares × $0.025 = $250 (a total of $500 a year). The amount is fixed: it does not depend on the profit for the year, and it is paid before any ordinary dividend.

Preference shares can be either redeemable, which means they will be repaid on a fixed date in the future, or irredeemable, which means that they will never be repaid.

Redeemable preference shares are effectively the same as long-term loans, and therefore the dividends are shown together with interest on the Statement of Profit or Loss, and the nominal value of the shares is shown on the Statement of Financial Position under the heading “Non-current liabilities”.

Irredeemable preference shares are more like ordinary shares (except for the fixed dividend) and therefore the dividends do not appear in the Statement of Profit or Loss, and the nominal value appears under the heading “Capital” on the Statement of Financial Position.

13 The Statement of Comprehensive Income

Although unrealised profits (which for this exam will only ever mean profit on revaluation) do not appear in the Statement of Profit or Loss, to show more clearly what is happening a company is required to produce a Statement of Comprehensive Income.

This is identical to the Statement of Profit or Loss, but any profit on revaluation is shown at the very end - after the profit for the year.

	$
Revenue	100,000
Cost of sales	(40,000)
Gross profit	60,000
Other income	2,000
	62,000
Distribution costs	(26,000)
Administrative expenses	(9,000)
Operating profit	27,000
Finance costs (interest)	(2,000)
Profit before tax	25,000
Income tax expense	(5,000)
Profit for the year	20,000
Other comprehensive income
Surplus on the revaluation of non-current assets	5,000
Total comprehensive income for the year	25,000

IAS 1 calls this the statement of profit or loss and other comprehensive income. The profit for the year of $20,000 goes to retained earnings; the revaluation surplus of $5,000 goes to the revaluation reserve. Total comprehensive income is the two together.

14 The Statement of Changes in Equity

The statement of changes in equity explains why each part of equity has changed during the year. It has a column for each part of equity and a total column. Each column starts with the balance brought forward from last year’s statement of financial position, adds or deducts the changes in the year, and ends with the balance carried forward to this year’s statement of financial position. This is the statement for the company in sections 4, 5 and 13:

	Share capital $	Share premium $	Revaluation reserve $	Retained earnings $	Total $
Balance b/f	40,000	–	–	27,000	67,000
Surplus on revaluation			5,000		5,000
Profit for the year				20,000	20,000
Dividends paid				(5,000)	(5,000)
Issue of share capital	10,000	10,000			20,000
Balance c/f	50,000	10,000	5,000	42,000	107,000

Each column adds down. Retained earnings: 27,000 + 20,000 − 5,000 = $42,000. Total: 67,000 + 5,000 + 20,000 − 5,000 + 20,000 = $107,000. The closing balances are the equity in the statement of financial position in section 5: share capital $50,000; capital reserves $15,000 (share premium $10,000 + revaluation reserve $5,000); revenue reserves (retained earnings) $42,000; total $107,000. The share issue raised $20,000 — $10,000 nominal value and $10,000 premium. Dividends appear here, never in the statement of profit or loss.

Where each line comes from:

Line	Where the figure comes from	Column it changes
Balance b/f	Last year’s closing equity, in last year’s statement of financial position	Every column
Issue of shares	Number of shares × nominal value; number of shares × (issue price − nominal value) (section 9)	Share capital; share premium
Surplus on revaluation	Other comprehensive income in the statement of comprehensive income (sections 11 and 13)	Revaluation reserve
Profit for the year	The last line of the statement of profit or loss (section 4)	Retained earnings
Dividends	Dividends approved in the year, not those only proposed (section 7)	Retained earnings (deducted)
Balance c/f	Add down each column	Every column: the equity in the statement of financial position

A bonus issue (section 10) and a transfer of excess depreciation from the revaluation reserve to retained earnings (section 11) move an amount from one column to another: one column goes up and the other goes down by the same amount, so the total does not change. Because every column adds down, any one missing figure can be found from the others.

Jabari Ltd, a company in Kenya, has a year end of 31 December. Its statement of changes in equity for the year ended 31 December 2025 is shown below, with six figures missing (A to F).

	Share capital	Share premium	Retained earnings	Total
	$	$	$	$
Balance b/f	60,000	15,000	48,000	123,000
Issue of shares	A	B		32,000
Profit for the year			C	C
Dividends paid			(10,000)	(10,000)
Balance c/f	D	E	71,000	F

During 2025 the company issued 20,000 shares of $1 each at $1.60 per share. The dividends paid were last year’s final dividend of $6,000, approved by the shareholders at the annual general meeting in March 2025, and an interim dividend of $4,000. On 31 December 2025 the directors also proposed a final dividend of $12,000, which the shareholders will vote on at the annual general meeting in 2026.

Calculate the missing figures A to F, and state whether the proposed final dividend of $12,000 should appear in the statement.

Figure	Working	$
A Share capital issued	20,000 shares × $1 nominal value	20,000
B Share premium	20,000 shares × ($1.60 − $1.00)	12,000
C Profit for the year	Retained earnings column: 48,000 + C − 10,000 = 71,000, so C = 71,000 − 48,000 + 10,000	33,000
D Share capital c/f	60,000 + 20,000	80,000
E Share premium c/f	15,000 + 12,000	27,000
F Total equity c/f	123,000 + 32,000 + 33,000 − 10,000	178,000

Check: A + B = 32,000, the cash raised (20,000 × $1.60). F is also the sum of the closing balances: 80,000 + 27,000 + 71,000 = 178,000.

The proposed final dividend of $12,000 does not appear. At 31 December 2025 it is only a proposal — the shareholders have not approved it — so it is not a liability and is not deducted from retained earnings. It is disclosed in a note, and will be deducted from retained earnings in 2026, when it is approved.

In the lecture that covers sections 12 to 14, the tutor says you will not be asked to produce a statement of changes in equity. You should still be able to work out every figure in it, including a missing one, as in Example 7.

15 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.

Answer the questions one at a time. Your progress is saved so you can leave and come back.

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