IA2: REGULATORY FRAMEWORK OF FINANCIAL ACCOUNTING 1

This unit looks at the regulatory framework of financial accounting 1. This is discussed using the sub units; classification of companies; capital structure; and presentation of financial statements.

REGULATORY FRAMEWORK OF FINANCIAL ACCOUNTING 1

CLASSIFICATION OF COMPANIES

Under section 21 of CAMA 2004, an incorporated company may be any of the following:

(a) Company limited by shares. This is a company where the liability of each member to contribute to the assets of the company in the event of winding-up or liquidation is limited by the Memorandum and Articles of Association to the amount, if any, unpaid on the shares held by him.

(b) Company limited by guarantee. In this type of registered company, the liability of each member to contribute to assets of the company in the event of winding up, is limited by the Memorandum and Articles of Association to the amount which the member undertakes topay.

Unlike companies limited by shares, a company limited by guarantee, shall not be registered with a share capital (see section 26 of the CAMA 2004). Such companies are usually formed to promote commerce, art, science, education, research and similar objects.

The name of the company shall end with the word limited by guarantee or Ltd/Gte.

(c) Unlimited Company. In an unlimited company, there is no limit on the liability of its members. The name of the company shall end with unlimited or Ultd. (see Section 29 of  CAMA 2004).

Any of the foregoing types of company may be a:

(a) Private limited liability company, or

(b) Public limited liability company

A private limited liability company: Section 22 of CAMA defines a private company as one which is stated in its Memorandum and Articles of Association to be a private company and which its articles of Association:

(a) Restricts the right to transfer its shares;

(b) Limits the number of its members to fifty;

(c) Prohibits any invitation to the public to subscribe for any shares or debentures of the company;

(d) Requires that appointment of directors may be done by an ordinary resolution; and

(e) Requires that the name of the company shall end with the word Limited or Ltd (see Section

A public limited liability company: A public company is any other than a private limited liability company. It, however, has the following characteristics:

  1. The word “public” is stated in its Memorandum of Association;
  2. Does not restrict the right to transfer its shares;
  3. Does not limit the number of its members;
  4. Makes its accounts public for all to see;
  5. Places invitation to the public to subscribe for any shares or debentures of the company;
  6. Appointment of directors may be done individually on separate resolutions. Note, however, that one of its members may move that all directors be appointed by one resolution and where this is not opposed, then the public company’s directors may be appointed by a singl resolution;
  7. Any public company can issue its shares and debentures by way of prospectus or statement in lieu of prospectus in appropriate circumstances after presentation to the Securities and
  8. Exchange Commission; and
  9. The name of the company shall end with word Public Limited Company or Plc.

SELF ASSESSMENT EXERCISE

What is the difference between company limited by shares and company limited by guarantee?

CAPITAL STRUCTURE

The capital structure of a company consists of ordinary shares, preference shares and debentures.

Under these structures, there are different types:

Types of capital

Nominal or Authorized: This is the initial capital with which the company is registered. It does not change within a short time except where the capital is increased. It is therefore, the maximum capital at any given time. There are specified minimum capitals as stipulated by law. The authorized minimum share capital of a private company is N10,000,00 and N500,000.00 for a public company.

The subscribers of the Memorandum must together take shares of a value not less than 25% of the authorized capital.

Issued Capital: The portion of the nominal capital or authorized capital issued or made available to shareholders. It must not at any time be less than 25% of the authorized capital.

Paid-up capital: This is that part of the share capital which has been issued to and paid for by the shareholders.

Reserve capital: It is that portion of uncalled capital which a company limited by shares has, by special resolution, determining that it will not be capable of being called up except for the purpose of winding up the company.

Note that an unlimited company, which resolves to be registered as a limited company, may provide for reserve share capital on re-registration.

Equity Share capital: This means a share other than a preference share, which does not carry fixed return on investment: for example, ordinary shares.

CLASSES OF SHARE

Any company, authorized by its articles, the Act or any other law, may issue different classes of shares. Such a share must not have more than one vote or no vote at all. A company may, however, subject to the above principle, issue shares having preferred, deferred or other special rights or restrictions, such as, regards dividends or return of capital. The usual classes of shares are:

Ordinary shares: They have no special rights and carry no fixed rate of return on the capital. They bear the major financial risk of the company and are therefore often called the equity shares of the company. They cost much less than the ordinary shares and preference shares. In voting matters, deferred shareholders are more at an advantage compared with preference shareholders who are regarded as investors.

Payment for share

This may be in cash or if authorized by the articles, by property or services and, if payment is not in cash, the consideration must be valued by an expert. See section 135-137 of CAMA (2004). It should be noted that at formation of a company, there is actual payment for the shares.

Membership of the company:

Membership of the company is made up of:

(a) Subscribers who are deemed to have agreed to become members and whose names must be entered in the register of members.

(b) Every other person who agrees in writing to become member a member by payment and allotment of shares and such person’s name is entered in the register of members.

Public Issue of shares

Only public companies can issue their shares or debentures to the public, usually by way of a prospectus but where no prospectus is issued, a statement in lieu of prospectus is filed. Filing the prospectus is no longer a prerequisite for the formation of a public company. The company may now be formed while work on the prospectus is carried on, pursuant to issuance of shares.

Issue of Shares at Premium

Share are said to be issued at a premium where the price at which they are issued is higher than the par (nominal) value of the share. Thus, the shares of a company with nominal or par value of N1.00 per share may be issued at N1.20. When a company issue shares at a premium, the sum equal to the aggregate amount or value of the premium on those shares must be transferred to an account called “share premium account”. This account cannot be used to pay dividend but can be used for the following:

(a) Paying up unissued shares of the company to be issued to members as fully paid bonus shares;

(b) Writing off the preliminary expenses of the company or the expenses of or commission paid  or discount allowed on any issue of shares of the company; and

(c) Providing for the premium payable on redemption of redeemable preference shares of the company.

Issue of Shares at a Discount

Shares may be issued at a discount which means that the amount paid by the applicants/subscribers is less than the par(nominal) value of the share. This could be possible only where a resolution:

(a) Authorizes the issue of shares at a discount; or

(b) Specifies the maximum rate of discount at which the shares are to be issued; and

(c) Stipulates the time frame of the issue which must be within the month after the date on which must be within the month after the date on which the issue is sanctioned by the court or within such extended time as the court may allow.

Allotment of Shares

Subject to the provisions of the Investment and Securities Act, the power to allot shares is vested in the company which it may delegate to the director, subject to the conditions or directions that may be imposed by Articles or from time by the company in General Meetings.

The method of application for allotment is dependent on the type of company. In the case of a private company or a public company, where the company issues shares and a member indicates the number of shares which he wishes to purchase. In the case of a public company, where the issue of shares is public, subject to any condition that may be imposed by the Securities and Exchange

Commission, the application for allotment is made by completing and returning to the company the form of application as prescribed by the Articles.

Upon the receipt of an application, a company shall, where it wholly or partially accepts the application, make an allotment to the applicant and within 42 days after the allotment, notify the applicant of the fact of the allotment and number of shares allotted to him. The application is an offer to take shares and allotment amounts to an acceptance. An applicant shall have the right at any time before allotment, to withdraw the application by written notice to the company.

ACQUISITION OF OWN SHARES

Section 160(2) of CAMA states the reasons why a company may wish to purchase or own its shares.

They include:

(a) Settling or compromising a debt or claim asserted by or against the company;

(b) Eliminating fractional shares;

(c) Fulfilling the terms of a non-assignable agreement under which the company is obliged to acquire from an officer or employee of the company;

(d) Satisfying the claim of a dissenting shareholder; and

(e) Complying with a court order.

Conditions for purchase of own shares

(a) The shares of a company shall be purchase only out of the company’s profits which would otherwise be available for dividend or the proceeds of a fresh issue of shares, made for the purpose of the purchase.

(b) Redeemable shares shall not be purchased at a price greater than the lowest price at which they are redeemable or shall be redeemable at the next date thereafter at which they are due or liable to be redeemed

Reciprocal Acquisition of a Holding Company’s Shares by its Subsidiary

Section 165 of CAMA, allows a subsidiary to acquire or retain the shares of its holding company, under the following conditions:

(a) The subsidiary company may acquire the shares of its holding company as a personal  representative or trustee of its holding company; and

(b) A subsidiary company which had acquired the shares of its holding company before 1990, shall continue to retain such shares but shall not be entitled to vote at the meetings of its holding company, and shall not acquire further shares in the holding company, particularly where their security may be in danger.

DEBENTURES

This is an acknowledgement of indebtedness issued by a company to a lender and it is normally by way of a deed.

Securities and Charges

This is a collateral given by a debtor to secure a loan and it is meant for protection and assurance that the loan will be paid when due.

(a) Perpetual debenture: This is a debenture that is made irredeemable or redeemable at a very long period of time.

(b) Convertible debenture: This is a type that may be converted to the shares of the company which issued it. See S.172 of CAMA 2004.

(c) Secured and naked debenture: Security here may either be fixed or floating. See s.173 of CAMA 2004.

(d) Redeemable debenture: This may be redeemed at any time. See S.174 of CAMA 2004.

For detailed provisions of the CAMA on the creation of debentures and debenture stock, please refer to section 166 to 210 of the Act.

SHAREHOLDERS’ FUND

Shareholders’ fund is made up of ordinary share capital, preference share capital and reserves. Ordinary share capital/preference share capital

As earlier discussed above, they are part of the share capital of the company, with different rights to dividend and capital repayment in accordance with the Articles of Association of the company.

Reserves: It is an appropriation of the company’s profit during a financial year.

CLASSES OF RESERVES

Revenue reserves

A revenue reserve is where an amount has been voluntarily transferred from the profit and loss appropriation account by debiting it, thus reducing the amount of profits left available for cash dividend purposes. It might be for some particular purpose, or the amount could be called up in future to help swell the profit shown in the profit and loss appropriation account, as being available for dividend purposes.

General reserves

A company might create a general reserve account to take care of unforeseen circumstances, instead of paying out the entire amount in form of dividend.

Capital reserves

This is a reserve that is not readily available for transfer to the profit and loss appropriation account, to swell the profit shown as available for cash dividend purpose.

The following types of capital reserves are created in accordance with the Act:

(a) Capital redemption reserve fund is created by law to meet the following:

(i) paying up unissued shares of the company as fully paid bonus issues; and

(ii) applied in redeeming preference shares or debentures.

(b) Share premium account: This is an account created from issuing shares at an amount higher than the nominal value. The account is used to meet the following:

(i) writing off preliminary expenses;

(ii) writing off expenses and commission paid on the issue of shares and debentures;

(iii) writing off discount on shares or debentures issued; and

(iv) providing for any premium payable on redemption.

 (c) Revaluation account: A revaluation account is usually created when the value of existing assets are either increased or decreased in line with the dictates of the market.

SELF ASSESSMENT EXERCISE

What do you understand by shares issued at premium and shares issued at discount?

PRESENTATION OF FINANCIAL STATEMENTS

Duty to keep Accounting Records: Every company must keep accounting records that will be sufficient to show and explain the transactions of the company so as to:

(a) Disclose with reasonable accuracy, at any point in time, the financial position of the company; and

(b) Enable the directors to ensure that the financial statements comply with the requirements of section 331 of CAMA 2004 as to form and contents of the company’s financial statements.

Contents of accounting records

(a) Entries from day to day of all sums of money received and expended by the company and  the matters in respect of which they take place;

(b) A record of the assets and liabilities of the company.

The accounting records of a company dealing in goods shall contain: amongst other things:

(a) Statements of stock held at the end of the financial year;

(b) Statements of stock takings from which the annual statements of stocks in (a) above are prepared; and

(c) Statements of all goods sold and purchased other than by retail trade.

Location and Presentation of accounting Records: the accounting records shall be kept at the company’s registered office or such other place in Nigeria as the directors think fir and will at times be open to inspection by officers of the company. A company is required to keep the accounting records for a period of six(6) years from the date on which they were made.

Directors’ Duty to prepare Annual Accounts: The directors must prepare financial statements for the relevant accounting period. At the first meeting of the Board after incorporation, the directors must determine to what date each year, the financial statements shall be made up and notify the Commission within 14 days of the determination.

Contents of Financial Statements (Section 334): The financial statement of a company should include:

(a) Statement of the accounting policies;

(b) The balance sheet as at the last day of the company’s accounting year;

(c) A profit and loss account or in the case of a company not trading for profit, and income and expenditure account for the year;

(d) Notes on the accounts;

(e) The auditors’ report;

(f) The directors’ report;

(g) A cash flow statement;

(h) A value-added statement for the year;

(i) A five-year financial summary; and

(j) In the case of a holding company, the group financial statements.

However, the financial statements of a private company need not include matters stated in paragraph (a), (g), (h), and (i) above.

Directors’ report: The Directors of a company shall in respect of each year, prepare report:

(a) Containing a fair view of the development of the company and its subsidiaries during the financial year; and

(b) Stating the amount, if any, which they recommend should be paid as dividend and the amount they propose to carry to reserve.

MODIFIED FINANCIAL STATEMENTS OF SMALL COMPANIES

Under Section 351 of CAMA 2004, a company qualifies as a small company in a year, if in that year, the following conditions are satisfied:

(a) The company is a private company having share capital.

(b) Its turnover for that year is not more than N2 million or such amount as may be fixed by the Corporate affairs Commission.

(c) The company’s net assets value is not more than N1 million or such amount as may be fixed by the commission.

(d) None of its members is an alien.

(e) None of its members is a Government or Government corporation or agency or its nominee.

(f) The directors hold not less than 51 percent of the company’s equity share capital.

The Act allows a small company to deliver a modified balance sheet which is an abbreviated version of the full balance sheet. A small company is not required to deliver its profit and loss account to the Corporate Affairs Commission.

ANNUAL RETURNS (SECTIONS 370 – 378)

Every company shall, at least, once in every year, make and deliver to the Commission, an annual return but the company need not make a return in the year of its incorporation. The annual return of a company having shares other than a small company shall contain, among other things, a register of members and debenture holders, indebtedness of the company, past and present members and directors.

FORMATS OF FINANCIAL STATEMENTS

Section C of the Second Schedule of the Act, provides two balance sheet formats and four income statement formats. A reporting entity is required to choose any of the formats in presenting its balance sheet and profit and loss accounts. In this unit, we present only the format relating to group companies.

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Self assessment exercise

Outline according Section 334 of CAMA what the financial statement should include.

CONCLUSION

In conclusion, you have learnt that Financial Accounting Standard Board (USA) has defined conceptual framework as a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent (accounting) standards and that prescribes the nature, function and limits of financial accounting and financial statements.

Some arguments hold that some standards concentrated on income statement and others concentrated on balance sheet. An unambiguous definition of income and value would ensure that all financial statements have equal usefulness to different users groups.

Counter argument might be that financial statements intended for variety of users and may not be possible to devise single conceptual framework suiting all users. May need variety of accounting standards, each produced for different purpose (and with different concepts as basis).

 

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