ZIMSEC O Level Principles of Accounting: Accounting for Limited Liability Companies: Introduction

  • It is important to note that all accounts are prepared on the basis that the owner and his/her business are two separate persons
  • This does not matter if the business is not considered a separate legal entity for example partnerships and sole trader businesses
  • However actual companies have certain accounting terms and treatments that make them unique
  • Until now we have been looking at the accounting for sole traders and partnerships
  • Now we will look at the unique nature of limited liability companies  or companies as they are known

The nature and need for companies

  • When a business is small it is easy to control and normally the owner(s) runs and controls it as well
  • Examples of these businesses include partnerships and sole traders
  • Since these people control and run their own business they ought to bear the responsibility if their businesses fail due to their decisions
  • For this reason if any of these businesses incur debts the owners have unlimited liability
  • This means that the owners can lose their private property in settlement of debts incurred by their businesses in the event that the amount invested in the businesses fail to cover these debts
  • However as these businesses grow the owners might have to hire specialists to run these businesses
  • At this stage the owners usually are no longer be the ones controlling the businesses
  • This is known as divorce of ownership from control
  • Indeed if you consider businesses such as Econet Wireless Zimbabwe you have owners who never even set foot in the business
  • It would be unfair to punish these people by taking their private property to settle debts incurred by the business since they have little control over the affairs of the business
  • For this reason owners of companies have limited liability
  • This means that in the event of liquidation or debts the owners can only lose what they had/ought to have invested

Accounting for Companies

  • Two things make companies unique:
  • They exist as a separate legal entity i.e. the business and the owner are treated as two separate entities
  • Owners have limited liability
  • In addition the capital of limited liability companies is divided into shares
  • To become a member/part owner of a company one has to buy shares and become a shareholder
  • As already pointed out above from an accounting point of view business are treated as separate entities anyway
  • So there is really no difference from the way most items are treated in the books of a company from say those of a sole trader
  • Companies have debtors(receivables), payables(creditors), capital, liabilities and they also have a Trading and Profit and Loss Account( Statement of Comprehensive Income) and a Statement of Financial Position
  • Despite differences in terminology there are no earth-shattering differences between accounting for companies and say sole traders
  • We will look at the accounting differences as we encounter them

More on companies

  • Shareholders own the company please click here to learn more about shares
  • These shareholders select a Board of Directors at an event known as the Annual General Meeting (AGM) which has to be held by each company at least once a year according to the law
  • The Board of Directors run and control the company on behalf of the shareholders
  • The Board of Directors are stewards in essence
  • The company is a separate legal entity i.e. it treated as a separate juristic person at law for example it can sue or be sued in its own name. It can even sue its shareholders
  • Companies may also use Debentures to increase their capital click here to learn more about debentures

NB

  • For companies at Ordinary Level you are only supposed to know the following:
  • Definition to basic terms
  • The structure of the Trading and Profit and Loss Account ( Income Statement)
  • Extracts from the Statement of Financial Position especially showing the Share Capital Part
  • Company accounts are a long and complex topic you will do well to stick to these requirements

To access more topics go to the Principles of Accounts Notes.