A Company Is Formed

A Company Is Formed

A company is formed

Two businessmen, Jones and Brown, each provide £2,500 capital to form a company. On April 6, 2003, they open a company banking account (entirely separate from their private accounts). Into this company account they pay the sum of £5,000. The company's balance sheet, immediately after the opening of the banking account, is as follows:

Liabilities Assets

It is a tradition that liabilities are listed on the left-hand side of a balance sheet and assets on the right.

In this balance sheet the company clearly has assets worth £5,000 cash at the bank. But why a liability of £5,000 called 'Capital'? Isn't a liability a debt?

It will be noted that the records on this balance sheet are those of the company and not of the individual owners. From this it is clear that the company owes Jones and Brown the sun of £5,000 with which they opened the company's account, so that this amount is a liability of the company to its owners, who are the providers of its capital, and are thus its creditors under the heading 'Capital'.

In the balance sheet, therefore, an important distinction must be kept in mind between a company and the individuals who are its members and own its shares.

Thus the 'Issued Capital' of a company is liability to its shareholders, proportionate to their holding, since it is they who provide the capital.

At the outset of their business Jones and Brown agreed not to distribute any profits during their first accounting year, but to retain any profits as reserves. After a period of six months, it is found that on their trading account (a separate account) they have reduced their stock-in-trade by C500 to yield a profit of £1,500. The gross takings (£2,000) have been deposited as cash at bank) increasing the figure for this item to £2000.

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Read more? How Trading Profits Figures Are Reached



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