understand the meaning of the term limited liability

5.3 Limited Companies – Limited Liability

Objective

By the end of this lesson you should be able to:

• Explain the meaning of limited liability and separate legal entity.
• Define equity and describe the typical capital structure of a limited company.
• Distinguish between issued, called‑up and paid‑up share capital.
• Explain the differences between share capital and loan (debenture) capital, and between preference and ordinary shares (including redeemable vs. non‑redeemable).
• State the advantages and disadvantages of operating as a limited company.
• Identify a shareholder’s maximum possible loss.

1. What “Limited Liability” Means

• A limited company is a separate legal entity – it can own property, sue and be sued in its own name.
• Shareholders own the company only by holding shares.
• Their financial responsibility is limited to the amount they have agreed to pay for those shares (the unpaid portion of called‑up capital). Personal assets such as a house, car or savings are not at risk.
• If the company cannot pay its debts, creditors can claim **only** against the company’s assets; the most a shareholder can lose is the unpaid amount on his/her shares.

2. Equity – The Owners’ Interest

Equity represents the owners’ residual interest in the business after all liabilities have been deducted. In a limited company equity is shown in the Statement of Changes in Equity and normally consists of:

3. Preference Shares – Redeemable vs. Non‑Redeemable

• Redeemable preference shares: the company can buy them back (redeem them) at a predetermined date or price.
• Non‑redeemable preference shares: the company cannot force a redemption; they remain part of the capital for the life of the company.
• Both types carry a fixed dividend and have priority over ordinary shares, but only redeemable shares affect the capital redemption reserve when they are bought back.

4. Stages of Share Capital

When shares are issued they move through three distinct stages:

1. Issued capital – total nominal value of all shares that the company has offered for subscription.
2. Called‑up capital – the portion of issued capital that the company has formally requested shareholders to pay.
3. Paid‑up capital – the amount actually received from shareholders.

Numeric example

The remaining £3,000 is an unpaid liability of the shareholders until it is called and paid.

5. Share Capital vs. Loan (Debenture) Capital

6. Continuity of Business

• A limited company has perpetual succession – it continues to exist despite changes in share ownership, the death or withdrawal of shareholders, or the resignation of directors.
• This continuity is a direct consequence of the company’s status as a separate legal entity.

7. Advantages of Limited Liability

• Personal wealth of shareholders is protected – only the unpaid amount on shares is at risk.
• Greater confidence for lenders and suppliers because the company has its own legal identity and assets.
• Ease of raising large amounts of finance through the issue of ordinary and preference shares (including redeemable types).
• The company can own property, sue and be sued in its own name.
• Perpetual succession ensures business continuity.

8. Disadvantages of Limited Liability

• More complex and costly to set up and run – registration, filing of annual accounts, statutory returns, and maintaining registers.
• Strict regulatory requirements (directors’ report, audit thresholds, etc.).
• Potential dilution of control when many shareholders hold voting rights.
• Dividends can be paid only from profit after interest on loan capital has been deducted.

9. Shareholder’s Maximum Loss

The maximum loss a shareholder can suffer is:

Unpaid amount on called‑up shares + any amount already paid.

In practice, once the called‑up amount has been fully paid, the shareholder’s exposure is limited to the total amount they have paid for the shares.

10. How Limited Liability Works – Flowchart (Textual)

1. Investor subscribes for shares and pays the called‑up amount (paid‑up capital).
2. Company uses the cash to acquire assets and run its operations.
3. If profit is generated, the board may declare dividends to shareholders.
4. If losses occur and the company cannot meet its obligations, creditors can claim only against the company’s assets; shareholders lose at most the unpaid amount on their shares.

11. Illustrative Example

Emily buys 200 ordinary shares in TechSolutions Ltd at a nominal value of £5 each.

• Issued capital: 200 × £5 = £1,000
• Company calls up 80 % of nominal value: 200 × £4 = £800
• Emily pays £600 (75 % of the called‑up amount). The remaining £200 is still unpaid.

Later the company incurs debts of £50,000 it cannot settle. Creditors can only claim against the assets of TechSolutions Ltd. Emily’s personal assets are safe; her maximum loss is the £600 already paid plus the £200 she may still be called to pay (£800 total).

12. Summary

Limited liability means that a shareholder’s financial responsibility is confined to the amount unpaid on his/her shares, protecting personal assets and encouraging investment. The company, being a separate legal entity, owns its own assets, can continue indefinitely, and can raise finance by issuing equity (preference and ordinary shares) and debt (debentures). Understanding equity, the stages of share capital, the distinction between equity and debt, and the key advantages and disadvantages equips you to answer all Cambridge IGCSE Accounting questions on limited companies.