Apply double-entry principles to record the issue of shares and the appropriation of company profit, and prepare the equity section of a company balance sheet

What this dot point is asking

QCAA wants you to understand how a company, unlike a sole trader, raises and reports equity. You must record the issue of shares for cash, account for the appropriation of company profit through dividends and retained earnings, explain the separate legal entity and limited liability that distinguish a company, and prepare the equity section of a company balance sheet.

Company versus sole trader

A company differs from a sole trader in ways that change how equity is recorded:

• Separate legal entity: the company exists independently of its owners and can own assets, owe debts and sue in its own name.
• Limited liability: shareholders can lose only what they paid (or agreed to pay) for their shares; their personal assets are protected.
• Ownership by shares: ownership is divided into shares, which can be transferred without ending the business.
• Perpetual succession: the company continues regardless of changes in ownership.

Because of these features, company equity has two main parts (share capital and retained earnings) rather than a single owner's capital account.

Issuing shares

When a company issues shares for cash, it raises share capital. Issuing 100,000 ordinary shares at $2.00 each, fully paid:

• Debit Cash at Bank $200,000
• Credit Share Capital $200,000

Share Capital is an equity account. There is no GST on a share issue, because raising capital is not a taxable supply. Once issued, the shares belong to the shareholders, and the company has the cash to fund its operations.

Company profit and its appropriation

A company calculates net profit the same way as a sole trader, but the profit is not added to one owner's capital. Instead:

1. Net profit (after company income tax) is transferred to Retained Earnings, the accumulated undistributed profit of the company.

2. Directors may declare a dividend, a distribution of profit to shareholders. Declaring a dividend of $30,000 reduces retained earnings:

   • Debit Dividends (or Retained Earnings) $30,000
   • Credit Dividend Payable $30,000 (a current liability until paid)

3. When the dividend is paid: debit Dividend Payable $30,000, credit Cash at Bank$30,000.

Dividends are the company equivalent of drawings, but they are distributions of profit declared by directors, not informal withdrawals by an owner. Retained earnings carries forward the profit the company chooses to reinvest.

The equity section of a company balance sheet

A company balance sheet reports equity as:

• Share capital: the amount raised by issuing shares.
• Retained earnings: opening retained earnings + net profit - dividends.
• Reserves (where present): amounts set aside, such as a general reserve.

Total equity = Share capital + Retained earnings + Reserves

This contrasts with a sole trader, whose equity is a single figure: opening capital + net profit - drawings. The company structure separates the capital contributed by shareholders from the profit retained by the business, which gives analysts clearer information for the ratio analysis covered elsewhere in Unit 4.

Why the distinction matters

Separating share capital from retained earnings shows how the company is financed: how much came from shareholders contributing capital versus how much the business generated and kept. This split feeds directly into stability and return ratios (return on equity, gearing) and helps investors judge whether a company funds growth from profit or from raising new capital and debt.