Limited companies publish financial statements that serve shareholders and other users. For CIE Accounting, you need to know the main statements, the purpose of changes in equity, and how suitable finance is selected.

Limited company financial statements

A limited company usually prepares a statement of profit or loss, a statement of financial position, and a statement of changes in equity. Together, these show financial performance for the year, the financial position at the year end, and movements in shareholders’ funds.

Statement of profit or loss

The statement of profit or loss reports the company’s performance over an accounting period. A standard limited company format normally includes:

• revenue

• cost of sales

• gross profit

• distribution expenses

• administrative expenses

• operating profit

• finance costs

• profit before taxation

• taxation

• profit for the year

For companies, finance costs are especially important because they arise from borrowed finance such as loans or debentures. Taxation is also shown before arriving at the final profit figure.

A key exam point is that dividends are not treated as an expense in the statement of profit or loss. They are a distribution of profit to shareholders, so they affect equity rather than operating performance.

Statement of financial position

The statement of financial position shows the business at a single date. The main classifications are:

• non-current assets

• current assets

• equity

• non-current liabilities

• current liabilities

In limited company accounts, the equity section is important because it separates owners’ interests from liabilities owed to outsiders.

The equity section may include items such as ordinary share capital, share premium, retained earnings, and sometimes other reserves. Borrowed amounts, such as debentures, are not part of equity; they are liabilities.

Presentation points in company accounts

When preparing limited company financial statements, students should pay close attention to:

• correct headings, including the company name and date or period

• the distinction between current and non-current items

• the separate presentation of equity and liabilities

• correct treatment of finance costs and taxation

• correct updating of retained earnings after profit and dividends

Statement of changes in equity

A limited company does not only show closing equity; it must also show how that equity changed during the year.

This is the purpose of the statement of changes in equity.

This statement connects the profit made during the year with the year-end equity shown in the statement of financial position. It normally includes:

• opening balances for each equity item

• new share issues

• profit for the year

• other gains or reserve movements, if given

• dividends paid or proposed, where applicable

• closing balances

Its logic is straightforward:

• profit for the year increases retained earnings

• dividends reduce retained earnings

• a share issue increases share capital, and possibly share premium

• closing total equity must agree with the total equity figure in the statement of financial position

This statement is useful because it clearly distinguishes between money introduced by shareholders and profits generated by the company itself. It also helps users see whether equity has grown through successful trading, fresh capital, or reserve movements.

How the statements connect

These statements should not be studied separately because figures move from one statement to another. The profit for the year is calculated in the statement of profit or loss and then transferred to the statement of changes in equity. Closing retained earnings from the statement of changes in equity are then shown in the equity section of the statement of financial position. A new share issue also affects more than one statement because it changes both the financing of the company and the closing equity balance. Checking these links is an important way to avoid errors.

Identifying sources of finance for specified purposes

A limited company should choose finance by matching the source to the purpose, the time period involved, and the effect on risk and control.

Finance for long-term purposes

Long-term finance is appropriate when the benefit will last for several years, such as expansion, major equipment purchase, or development of operations. Suitable sources may include:

• ordinary share capital, which provides permanent finance and does not require interest payments, but may reduce existing shareholders’ control

• debentures, which provide long-term borrowed funds and may be suitable when the company can meet fixed interest costs

• long-term bank loans, which spread repayment over time

• retained earnings, which use internally generated funds without increasing liabilities

Finance for short-term purposes

Short-term finance is more suitable for temporary working capital needs or short cash-flow gaps. Possible sources include:

• bank overdraft, which is flexible for short-term cash needs

• trade credit, which delays cash payment to suppliers

The main principle is that a long-term purpose should usually be financed by a long-term source.

Using short-term finance for permanent investment can create pressure on cash flow.

Factors affecting the choice of finance

When deciding which source is most suitable, consider:

• purpose: what the funds are needed for

• duration: whether the need is short-term or long-term

• cost: interest, dividends expectations, and issue costs

• cash-flow impact: whether regular payments must be made

• control: whether ownership will be diluted

• risk: whether extra borrowing increases financial risk

• availability: whether the company can realistically obtain the finance

In exam answers, the strongest points do not simply name a source of finance. They explain why that source matches the specific purpose better than alternatives.

Common examination points

Students often lose marks by confusing equity and liabilities. Remember these rules:

• debentures belong in liabilities, not equity

• dividends reduce retained earnings; they do not reduce operating profit

• profit for the year is transferred through equity, not left unallocated

• the total closing figure in the statement of changes in equity must match total equity in the statement of financial position

• company financial statements must present capital and accumulated profits clearly and separately