There are a number of differences in the content of financial statements for companies: terminology used, tax, dividends and the content of the financial statements. I will briefly mention the differences here and then we will look at some of them in more depth in later posts.
Terminology
As we move from considering unincorporated entities (sole traders and partnerships) to companies, the accounting terminology differs to bring company accounts in line with accounting standards.
Tax in company accounts
So far, tax has not played a part in any of the accounting statements that we considered for sole traders and partnerships. This is because partnerships and businesses run by sole traders do not have separate legal personality, and therefore do not pay tax. The partners or the sole trader pay tax by reference to their own personal tax computations.
Companies however do have a separate legal personality, and as such, they must pay tax on their own account. In practice, therefore, the Profit and Loss Account of a company includes a statement of the tax the company should pay on its profits. This is corporation tax and will ultimately affect the profitability of the company.
Dividends
The owners of companies are shareholders and the shareholders’ return on their investment is the dividend that they may receive.
Like drawings that a sole trader takes from his business, a dividend is an appropriation of profits (after tax). It is not an expense of the business. In practice, dividends will usually appear in a financial statement called the ‘statement of equity’ (or ‘statement of changes in equity’) because they are transactions between the company and its shareholders. Dividends are also sometimes included in an addition to the Balance Sheet called the Statement of Changes in Equity (SoCiE). This shows profits brought forward and added to current year profits subject to any deductions for dividends. The resulting ‘Retained Earnings’ will appear on the bottom half of the Balance Sheet, showing the total profits carried forward to the next accounting period.
Capital accounts: the bottom half of the balance sheet
Company accounts follow a format which differs from those of sole traders and partnerships. The main difference relates to the bottom half of the Balance Sheet and this is due to the fact that the capital of a company consists of share capital, reserves and retained earnings.