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Unit VI · Limited companies and ratio analysis
10 min readConcept sheetOften a 5- or 10-mark question with journal entries

Limited companies and the issue of shares

A company is a separate legal person owned by shareholders with limited liability. Money received for shares goes to stated capital under the Companies Act No. 7 of 2007.

LawCompanies Act No. 7 of 2007
Key featuresSeparate legal person, limited liability, perpetual succession
Stated capitalTotal amount received for shares issued
Share typesOrdinary and preference shares

Introduction to corporates

A limited liability company is a separate legal person: it owns property, signs contracts, sues and is sued in its own name. Its owners, the shareholders, have limited liability: they can lose only what they paid, or agreed to pay, for their shares. The company has perpetual succession: it continues even when shareholders change. Day-to-day control rests with the board of directors, so ownership is separate from management. In Sri Lanka companies are governed by the Companies Act No. 7 of 2007. A private company ends its name with '(Private) Limited'. A company whose shares or other securities are listed on a stock exchange, such as the Colombo Stock Exchange, ends its name with 'PLC' (Public Limited Company); other limited companies end with 'Limited'.

Ordinary and preference shares

Ordinary sharesThe owners' risk capital. Carry voting rights. Dividends vary with profit and are paid after preference dividends. On winding up they are repaid last.
Preference sharesA fixed dividend (a stated percentage) paid before ordinary dividends. Usually no vote. Priority over ordinary shares for capital on winding up. May be cumulative and redeemable.

No par value: stated capital

Under the Companies Act No. 7 of 2007, shares of a Sri Lankan company have no par (nominal) value. All the money received for shares is credited to stated capital. Older and foreign textbooks use par value: each share has a fixed face value, and any amount received above it goes to a share premium account. Learn both: if a question gives a par value, use share capital and share premium; otherwise use stated capital.

Worked example 1: a public issue with oversubscription

Problem

Lakdiva Foods PLC offers 1,000,000 ordinary shares at Rs. 25 each, payable in full on application. Applications are received for 1,300,000 shares. The company allots 1,000,000 shares and refunds the excess. Issue costs of Rs. 400,000 are paid. Journalise.

Working
  1. Money received: 1,300,000 × 25 = 32,500,000. Dr Bank 32,500,000; Cr Share application 32,500,000.
  2. Shares allotted: 1,000,000 × 25 = 25,000,000. Dr Share application 25,000,000; Cr Stated capital 25,000,000.
  3. Refund: 300,000 × 25 = 7,500,000. Dr Share application 7,500,000; Cr Bank 7,500,000. The application account is now 32,500,000 − 25,000,000 − 7,500,000 = 0.
  4. Issue costs are deducted from equity, not expensed: Dr Stated capital 400,000; Cr Bank 400,000.
  5. Net stated capital from the issue: 25,000,000 − 400,000 = 24,600,000.
Answer

Stated capital rises by Rs. 24,600,000, equal to the net cash kept: 32,500,000 − 7,500,000 − 400,000 = Rs. 24,600,000.

Worked example 2: the same issue under the par value method

Problem

Suppose the 1,000,000 shares had a par value of Rs. 10 and were issued at Rs. 25 each. How is the Rs. 25,000,000 recorded under the older par value method?

Working
  1. Share capital at par: 1,000,000 × 10 = 10,000,000.
  2. Share premium: 1,000,000 × (25 − 10) = 15,000,000.
  3. Check: 10,000,000 + 15,000,000 = 25,000,000.
Answer

Par value method: share capital Rs. 10,000,000 and share premium Rs. 15,000,000. Under the 2007 Act: stated capital Rs. 25,000,000.

Worked example 3: rights issue and bonus (capitalisation) issue

Problem

(a) Kelani Paints PLC, with 4,000,000 ordinary shares, makes a 1-for-4 rights issue at Rs. 20; all rights are taken up. (b) It later makes a bonus issue by capitalising Rs. 5,000,000 of retained earnings.

Working
  1. (a) New shares: 4,000,000 ÷ 4 = 1,000,000. Cash: 1,000,000 × 20 = 20,000,000.
  2. (a) Dr Bank 20,000,000; Cr Stated capital 20,000,000.
  3. (b) No cash moves: Dr Retained earnings 5,000,000; Cr Stated capital 5,000,000.
  4. (b) Total equity is unchanged; only its make-up changes.
Answer

The rights issue raises Rs. 20,000,000 of new cash; the bonus issue moves Rs. 5,000,000 from retained earnings into stated capital.

In Sri Lankan business

When a Sri Lankan company makes an initial public offering (IPO) on the Colombo Stock Exchange, the issue is often oversubscribed, and the extra application money is refunded just as in the worked example.

Exam angle

Short answer: “What is stated capital?” The total amount received by a company for the shares it has issued; under the Companies Act No. 7 of 2007 shares have no par value.

Structured question: “Distinguish ordinary shares from preference shares.” Compare dividend (variable vs fixed, order of payment), voting rights, risk and priority on winding up; mention cumulative and redeemable preference shares.

Essay: “Explain the main features of a limited company and journalise an issue of shares with oversubscription and issue costs.” Features (separate legal person, limited liability, perpetual succession, separation of ownership and control), private vs public, stated capital, then the four journal entries with figures.

Remember it

Company features S-L-P-S: Separate legal person, Limited liability, Perpetual succession, Separation of ownership and management.

Read alongside the books on your syllabus: Dyckman, Hanlon, Magee & Pfeiffer, Financial Accounting · Weygandt, Kimmel & Kieso, Accounting Principles. Written from standard textbooks; faculty review in progress. Spotted an error? Report it.