prepare income statements, statements of changes in equity and statements of financial position

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Cambridge IGCSE Accounting 0452 – Topic 5.3: Limited Companies

Learning Objective

By the end of this lesson you should be able to prepare, for a financial year:

  • An Income Statement (Profit or Loss Account)
  • A Statement of Changes in Equity
  • A Statement of Financial Position (Balance Sheet)

1. Key Concepts

1.1 What is a Limited Company?

  • Separate legal entity – the company can own property, sue and be sued in its own name.
  • Limited liability – shareholders are liable only for the amount unpaid on their shares; personal assets are protected.
  • Perpetual succession – the company continues to exist despite changes in ownership or the death of shareholders.

1.2 Advantages & Disadvantages

AdvantagesDisadvantages
  • Limited liability for shareholders
  • Easy transfer of ownership (shares can be bought and sold)
  • Perpetual existence – business is not tied to owners
  • Greater ability to raise large amounts of capital
  • More regulation and statutory filing requirements
  • Higher set‑up and running costs (registration, audit, filing fees)
  • Potential double taxation (corporate tax + dividend tax for shareholders)

1.3 Capital Structure

  • Share capital
    • Issued share capital – total nominal value of shares that have been issued.
    • Called‑up share capital – amount that the company has asked shareholders to pay.
    • Paid‑up share capital – amount actually received from shareholders.
  • Types of shares
    • Ordinary (ordinary) shares – carry voting rights and receive dividends after preference shareholders.
    • Preference shares – receive a fixed dividend before ordinary shareholders.
      • Redeemable preference shares – the company can buy them back at a predetermined price.
      • Non‑redeemable preference shares – remain issued until the company is wound up.
  • Reserves – profits set aside for a specific purpose (e.g., re‑valuation reserve, legal reserve). They are part of equity but not share capital.
  • Retained earnings – accumulated undistributed profit; carried forward year after year.
  • Loan (debenture) capital – long‑term borrowing that appears under non‑current liabilities.

2. Preparing the Financial Statements

2.1 Income Statement (Profit or Loss Account)

The Income Statement shows the company’s performance over the reporting period.

Formula

Net Profit (or Loss) = Revenue – Expenses

ParticularsAmount (£)
Revenue (Sales)
Cost of Sales
Gross Profit
Administrative Expenses
Distribution Costs
Finance Costs (interest)
Net Profit before Tax
Tax Expense
Net Profit for the Year

2.2 Statement of Changes in Equity

Shows how owners’ equity changes during the year.

Formula

Closing Equity = Opening Equity + Net Profit – Dividends

ParticularsAmount (£)
Opening Equity (Share Capital + Retained Earnings + Reserves)
Add: Net Profit for the Year
Less: Dividends Paid
Closing Equity

2.3 Statement of Financial Position (Balance Sheet)

Shows the company’s financial position on a specific date.

Accounting Equation

Assets = Liabilities + Equity

Statement of Financial Position as at 31 December 20XX
Non‑Current Assets
Property, Plant & Equipment
Intangible Assets (e.g., patents)
Total Non‑Current Assets
Current Assets
Stock (Inventory)
Trade Receivables
Cash and Bank
Total Current Assets
Total Assets
Equity
Share Capital (issued, called‑up, paid‑up)
Reserves (if any)
Retained Earnings (Closing Equity – Share Capital – Reserves)
Total Equity
Non‑Current Liabilities
Long‑term Borrowings (debentures, loans)
Total Non‑Current Liabilities
Current Liabilities
Trade Payables
Accrued Expenses
Short‑term Borrowings
Total Current Liabilities
Total Liabilities
Total Equity and Liabilities

3. Worked Example – ABC Ltd.

Figures for the year ended 31 December 20XX

  1. Sales: £120,000
  2. Cost of Sales: £70,000
  3. Administrative Expenses: £15,000
  4. Distribution Costs: £5,000
  5. Interest Expense: £2,000
  6. Tax Expense: £6,000
  7. Dividends Paid: £4,000
  8. Opening Equity: Share Capital £50,000 + Retained Earnings £10,000 = £60,000
  9. Non‑Current Assets: £80,000
  10. Current Assets: Stock £12,000, Receivables £8,000, Cash £5,000
  11. Non‑Current Liabilities: Long‑term Loan £30,000
  12. Current Liabilities: Trade Payables £9,000, Accrued Expenses £3,000

Step 1 – Income Statement

ParticularsAmount (£)
Sales120,000
Cost of Sales70,000
Gross Profit50,000
Administrative Expenses15,000
Distribution Costs5,000
Interest Expense2,000
Net Profit before Tax28,000
Tax Expense6,000
Net Profit for the Year22,000

Step 2 – Statement of Changes in Equity

ParticularsAmount (£)
Opening Equity60,000
Add: Net Profit22,000
Less: Dividends4,000
Closing Equity78,000

Step 3 – Statement of Financial Position

Statement of Financial Position as at 31 December 20XX
Non‑Current Assets
Property, Plant & Equipment80,000
Total Non‑Current Assets80,000
Current Assets
Stock12,000
Trade Receivables8,000
Cash and Bank5,000
Total Current Assets25,000
Total Assets105,000
Equity
Share Capital (paid‑up)50,000
Retained Earnings28,000
Total Equity78,000
Non‑Current Liabilities
Long‑term Loan30,000
Total Non‑Current Liabilities30,000
Current Liabilities
Trade Payables9,000
Accrued Expenses3,000
Total Current Liabilities12,000
Total Liabilities42,000
Total Equity and Liabilities105,000

4. Common Pitfalls

  • Omitting the tax expense – this inflates net profit.
  • Confusing share capital with retained earnings. Share capital is the amount paid for shares; retained earnings are accumulated profits.
  • Mis‑classifying assets or liabilities as current/non‑current.
  • Failing to check that the balance sheet balances (Assets ≠ Liabilities + Equity).
  • Not adjusting for unpaid share calls or partially paid shares when calculating paid‑up capital.

5. Quick Checklist for Exam Questions

  1. Read the question carefully – note the reporting date and any figures that must be calculated.
  2. Start with the Income Statement – it provides the net profit needed for the equity statement.
  3. Prepare the Statement of Changes in Equity – add net profit to opening equity and subtract dividends.
  4. Transfer the closing equity figure to the equity section of the Balance Sheet.
  5. List assets in order: non‑current first, then current. Do the same for liabilities.
  6. Check the fundamental equation: Assets = Liabilities + Equity.
  7. Verify that the total of “Total Equity and Liabilities” equals “Total Assets”.

6. Flow of Information (Suggested Diagram)

Income Statement → Statement of Changes in Equity → Statement of Financial Position

The net profit from the Income Statement feeds into the Statement of Changes in Equity, which in turn supplies the closing equity figure for the equity side of the Balance Sheet.

7. Action‑Oriented Review of the “Limited Companies” Notes (Topic 5.3) Against the Cambridge IGCSE Accounting 0452 Syllabus

Syllabus requirement How the notes measure up Suggested improvement
5.3 – Limited companies – advantages/disadvantages ✔ Advantages & disadvantages are listed in a clear two‑column table. None needed – retain the table.
Capital structure – issued, called‑up, paid‑up share capital Definitions are provided, but the relationship between the three stages is not visualised. Add a concise flow diagram or bullet hierarchy showing: Issued → Called‑up → Paid‑up and include a short example (e.g., £10 nominal value, £8 called, £5 paid).
Types of shares – ordinary, preference (redeemable / non‑redeemable) Explanation is present, but the rights of each type are not summarised. Insert a comparison table highlighting voting rights, dividend priority, and redemption features.
Reserves and retained earnings – meaning and treatment in equity Covered, but the distinction between a reserve and retained earnings could be clearer. Provide a short “key differences” box and an example of creating a re‑valuation reserve.
Prepare the three financial statements for a limited company All three statements are shown with templates and a worked example. Include a quick “one‑minute checklist” at the end of each template to remind students of common omissions (e.g., tax, dividends, closing equity).
Interpret the accounting equation for a limited company Equation is stated and applied in the balance‑sheet template. Add a short “test your understanding” question: calculate missing figure given assets and equity.

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