A company is a voluntary business organization that is legally recognized and exists as a separate entity. It is considered an artificial individual with its unique signature or seal. For investors planning to venture their money and services into a certain corporation, a proper analysis of company accounts is crucial before putting their assets at stake. It includes proper studying of the company’s balance sheets, profit-loss statements, cash flow statements and various other documents that give a basic idea about the status of the company in question. This blog will help you comprehend the basics of company accounts introduction and thereby establish a strong foundation of the concept.
Important Features of a Company
Before getting to the management of the company accounts, we must first understand what a company is. The following are the important features defining a company:
Legal Incorporation - For the establishment of a company as a separate legal entity, it should be incorporated under the Companies Act 1956 or, the Companies Act 2013. These acts lay down the responsibilities of companies and their members, along with the guidelines for certain procedures concerning the company’s activity.
Perpetual Succession - A company can have investors all over the world, and all those people investing capital to it are its members or shareholders. Even if one of the members dies, the company continues to function incessantly.
Board of Directors - It is elected by the company’s shareholders for the management purpose. However, the ownership of the company resides with all its members and not just the Board.
Seal - Like every person has his unique signature, a company has its exclusive seal which is imprinted on all the agreements and documents pertaining to the company’s windings.
What is a Share in terms of Company Accounts Introduction?
A share is defined as a unit of ownership representing a part of the company’s combined capital. It is an element of company accounts which brings in investment in the form of money or other assets. It is mainly of two types -
Preferential Shares - Members holding preferential shares are given a fixed dividend irrespective of the profit earned by the company. Also, in case the corporation shuts down due to any reason, preference is given to these shareholders at the time of repayment.
Equity Shares - The amount of dividend received by these shares depends upon the net profit made by the company. Investors in such shares have the right to vote in the company’s decision-making process.
The Balance Sheet
The company accounts introduction is incomplete without the dissertation of the balance sheet. It is regarded as a statement of the company’s financial position at a given point of time, in terms of its assets, liabilities and shareholder’s equity such that the amount of assets is always equal to the sum of liabilities and equity.
Asset - It is a resource possessed by a financial entity that has a positive economic value.
Current Asset - It refers to all the assets that are on the balance sheet for less than a year. It includes the available cash at the time of preparation of the balance sheet, the money to be received from various sources, the stocked inventory and the prepaid expenses.
Non-Current Asset - It is also called a long-term asset as it remains on the balance sheet of company accounts for more than a year. It consists of the manufacturing units, equipment, land, property, furniture, etc.
Liability - It is a financial debt owed by a company to other entities as a result of past transactions or favours received as capital investment.
Current liability - It includes the amount payable to the suppliers, the payroll, and the tax.
Non-Current Liability - It comprises loans and other debts not required to be paid within a year.
Equity - It is the amount of money that would be left with the company after paying off all its liabilities. In other words, it represents the net worth of a corporation.
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Fun Fact: Did You Know?
Ronald Wayne, a self-taught computer engineer, co-founded Apple as a partnership with Steve Wozniak and Steve Jobs. He owned 10% of the company’s shares which he sold back to his partners for ＄800 just 12 days later. Today, a 10 percent stake in Apple would be worth about ＄94 billion, a fortune Wayne let slip out his hands.
FAQs on Introduction to Company Accounts for Beginners
1. What are the essential features that legally define a company?
A company is a distinct legal entity with several key features that separate it from other forms of business. According to the Companies Act, 2013, the primary features are:
- Separate Legal Entity: A company is legally independent of its members (shareholders). It can own property, enter into contracts, and sue or be sued in its own name.
- Limited Liability: The liability of the shareholders is limited to the amount unpaid on their shares. Their personal assets are not at risk for the company's debts.
- Perpetual Succession: The company's existence is continuous and is not affected by the death, insolvency, or retirement of its members.
- Common Seal: This acts as the official signature of the company, though amendments have made it optional if directors' signatures are present.
- Transferability of Shares: Shares in a public company are freely transferable, allowing for easy change of ownership.
2. How does a company's capital structure and liability differ from that of a partnership firm?
The main difference lies in liability and the scale of capital acquisition. In a company, members have limited liability, meaning their personal assets are protected from business debts. A company can raise substantial capital from the public by issuing shares. In contrast, a partnership firm has unlimited liability, where partners are personally, jointly, and severally responsible for the firm's debts. Their capital contribution is typically limited to the resources of the partners themselves and cannot be raised from the general public.
3. What is Share Capital and what are its main types shown in a company's Balance Sheet?
Share Capital refers to the funds a company raises by issuing shares to the public or private investors. As per Schedule III of the Companies Act, 2013, it is disclosed in the Notes to Accounts on the Balance Sheet under these main categories:
- Authorised Capital: The maximum amount of capital the company is authorised to issue, as stated in its Memorandum of Association.
- Issued Capital: The portion of the authorised capital that the company has offered to the public for subscription.
- Subscribed Capital: The portion of the issued capital that has actually been subscribed to (or accepted) by the investors.
4. Why are shares classified into Equity and Preference Shares? What is the fundamental difference for an investor?
Shares are classified to cater to different types of investors with varying risk appetites. The fundamental difference for an investor lies in risk and return. Equity Shares represent ownership and carry voting rights. They bear the highest risk as dividends are not fixed and are paid only after all other claims are met. However, they offer the potential for higher returns through dividends and capital appreciation. Preference Shares, on the other hand, carry preferential rights. Investors receive dividends at a fixed rate and have priority in repayment of capital during winding up. They carry lower risk but offer limited, fixed returns and typically do not have voting rights.
5. How does the Statement of Profit and Loss for a company differ from that of a sole proprietorship?
The primary difference is the mandatory format. A company must prepare its Statement of Profit and Loss strictly as per the format prescribed in Part II of Schedule III of the Companies Act, 2013. This format standardises the presentation of revenues and expenses, requiring specific disclosures like 'Revenue from Operations', 'Other Income', and 'Finance Costs'. A sole proprietorship, however, has no legally mandated format for its Profit and Loss Account and can prepare it as per general accounting conventions, making it far less structured.
6. Why must a company's Balance Sheet always balance? Explain with an example related to the issue of shares.
A company's Balance Sheet must always balance because it is based on the fundamental accounting equation: Assets = Liabilities + Equity. Every transaction has a dual effect that keeps this equation in equilibrium. For example, when a company issues 10,000 shares of ₹10 each for cash, the company's assets (in the form of cash in the bank) increase by ₹1,00,000. Simultaneously, the company's Share Capital (which is part of Equity) also increases by ₹1,00,000. Thus, both sides of the equation increase by the same amount, ensuring the Balance Sheet remains balanced.
7. What is the importance of a company's financial statements for its stakeholders?
A company's financial statements, including the Balance Sheet and Statement of Profit and Loss, are crucial for various stakeholders to make informed decisions.
- Investors use them to assess the company's profitability and financial health before buying or selling shares.
- Lenders and Creditors analyse them to determine the company's ability to repay debts.
- Management uses them for internal decision-making, performance evaluation, and strategic planning.
- Government and Tax Authorities use them to ensure compliance with regulations and for tax assessment purposes.
