Limited Companies - Part 2

The income statement for a limited company follows the same upper section (trading account) as for a sole trader — calculating gross profit in the same way. The difference lies in the lower section:

                                         $
Gross profit                             X
Add: Other income                        X
Less: Expenses (wages, rent, etc.)      (X)
Profit from operations                   X
Less: Debenture interest                (X)
Profit before tax                        X
Less: Corporation tax                   (X)
Net profit after tax                     X

Key additions compared to sole trader:

1. Debenture interest: A finance cost — deducted before calculating profit before tax. It is a contractual obligation to pay regardless of profit levels.

2. Corporation tax: A percentage of taxable profit paid to the government. For exam purposes, the amount is usually given. It is deducted after debenture interest to give net profit after tax (the amount available for dividends and reserves).

Appropriation section (continuation of the income statement):

Net profit after tax                     X
Less: Transfer to general reserve       (X)
Less: Preference dividend               (X)
Less: Ordinary dividend — interim       (X)
Less: Ordinary dividend — final (proposed)(X)
Retained profit for the year             X
Add: Retained earnings b/d              X
Retained earnings c/d                   X

The closing retained earnings (c/d) flows directly into the capital and reserves section of the SFP.

Dividends are the distributions of profit made to shareholders. There are two timing categories:

Interim dividends: Paid during the accounting year (e.g., a half-year payment). By the year end, these have already been paid — they have been debited from retained earnings and credited to cash. In the income statement, they are deducted in the appropriation section. Since they are already paid, they do NOT appear as a liability on the SFP at the year end.

Final dividends (proposed): Recommended by directors at the year end and approved by shareholders after the year end (at the AGM). At the SFP date, the dividend has been declared but not yet paid. Therefore:

• It is deducted in the appropriation section of the income statement (reducing retained earnings).
• It also appears as a current liability on the SFP (it is an obligation to pay shareholders).

Important: If the question says a dividend has been paid (cash has changed hands), it is NOT a liability on the SFP — it has already been settled. If it is described as proposed or declared but not paid, it IS a current liability.

Preference dividends: These are always based on the nominal value of preference shares × the fixed rate. They are paid before ordinary dividends. Unpaid preference dividends (from cumulative preference shares) accumulate — but at IGCSE level, detailed treatment of cumulative arrears is not required.

The SFP for a limited company follows the same structure as for a sole trader for non-current assets, current assets, current liabilities, and non-current liabilities. The difference is in the capital and reserves section at the bottom:

Capital and reserves                                    $
Ordinary share capital (X shares × $Y nominal)    X 000
8% Preference share capital (X shares × $Y)       X 000
Share premium                                      X 000
General reserve                                    X 000
Retained earnings                                  X 000
Total equity                                       X 000

Retained earnings in the SFP = Opening retained earnings + Net profit after tax − Dividends (paid and proposed) − Transfer to general reserve.

This is the same figure as 'Retained earnings c/d' in the appropriation section of the income statement.

General reserve: When the directors decide to transfer part of profits to a general reserve, it is moved from retained earnings to the general reserve. This protects the profit from being paid out as future dividends — it signals the company's intention to reinvest. Both balances remain in the capital and reserves section.

Debentures in the SFP: Debentures appear as non-current liabilities (assuming they are long-term). They are separate from equity and must not be included in the capital and reserves section.

Current liabilities will include:

• Trade payables
• Accruals
• Proposed final dividend (if not yet paid)
• Short-term portions of loans
• Corporation tax payable (if not yet paid)