Various Types of Companies in the United Kingdom - Coursework Example

Running Head: ABBREVIATED OF YOUR CHOICE (all caps) and Section # of The report explains the various types of companies that can be established in the United Kingdom with a emphasis on corporate governance. It also highlights the importance of the income statement and the various methods that can be used. The report discusses in detail the full costing method and the activity based costing method that provides the basis for setting up the accounting information and reporting systems. Business Information Public Company A public company is one that is limited by shares. The company has its own memorandum of association and articles of association. In UK, the share capital of a public company must be greater than £50,000. The company has a greater borrowing power, limited liability and a board with the experienced people to manage the company. But at the same time, there are strict regulations to be followed in the UK, public disclosure of financials and relevant information as well as loss of control exists. There is also a greater distribution of profits in a public limited company (Gillhams, 2005). Private Company On the other hand, a private company is any company that is not public. This is the most common form of acting subsidiaries in the UK. A private company does not have to adhere to strict regulations of the government. At the same time, there is no need for disclosure of any kind of information. The company is the sole owner and controller, and the receiver of profits. But a private company has unlimited liability and will not be able to borrow from the public through shares or dentures. Hence, it will be limited by capital (Gillhams, 2005). Concept of Limited Liability The concept of limited liability says the shareholders (or owners) have a limit on their liabilities for their company’s debt obligations. The shareholders are only liable for the amount that they have invested in the company and therefore, cannot be sued for further repayment of further obligations if th company is declared insolvent (Gillhams, 2005). Guiding Principles of Corporate Governance in the UK The corporations in the UK are to comply with combined code of corporate. This code lays down the principles that force the companies to develop standards for good practices. It relates to the business issues such as the board of directors, compensations, accountability and audit and the relations with the shareholders. All the corporations in the UK are to comply with the strict rules and regulations of this combined code (FRC, 2010). The public companies are made to declare the ways through which they have complied with the code and to provide a proper reason if they have not followed a particular code. From 2010 onwards, all the companies including those that are incorporated outside will be forced to comply with the combined code of corporate governance (FRC, 2010). Income Statement The basic purpose of the income statement is to indicate the profit (or loss) of the company for a specific period of time. The income statement shows all the revenue streams as well as all the expenses incurred during that period of time (Warren , 2006). The gross profit is calculated by deducting cost of goods sold from the sales. It is the residual profit which signifies the efficiency of usage of the labor, raw materials and other direct costs in the manufacturing process. The earning before tax (EBT) is calculated by deducting all the indirect expenses and other costs including the finance cost from the gross profit whereas the after tax profit denotes the final income earned by the company. The retained income, also known as the retained earnings is a part of the final income that the company retains and reinvests in the company for future growth (Warren , 2006). XYZ Company Ltd   Income Statement   For the year ended June 30th 20XX   Sales £200   COGS 120   Gross Profit 80   Less: Selling, General and Administrative   Variable SG&A 15   Fixed SG&A 12 27   Net Profit 53           The cost of sales is established through the absorption costing method. In this cost of goods sold are included the direct materials used, direct labor consumed and other direct costs that have incurred in the manufacturing of the relevant products (Warren , 2006). The owner’s equity is made up of revenues and expenses. The owner’s equity increases with the increasing revenue whereas the increasing expenses decrease the owner’s equity. This is the link between the income statement and the balance sheet (Warren , 2006). Depreciation It is defined as a non-cash expense that reduces the value of an asset as a result of wear and tear and age. Assets lose their worth over time and are replaced as soon as their useful life is over. Depreciation basically decreases the taxable income but at the same time increases the cash flows of an organization (Warren, 2006). There are several accounting methods that can be used to calculate depreciation of an asset. Straight Line Method: Depreciation = (Cost – residual value)/Useful life Double Declining Method: Book Value * Depreciation rate Sum of the Years Digit Method: (Cost – salvage value) * fraction Full Costing Full costing is an accounting method that is used to value the firm’s total inventory by including all the manufacturing costs incurred in the production of the respective goods. This method calculates the unit cost of the product by taking into account all the relevant costs. In this method, the cost is transferred to the cost of goods sold as soon as the sale is made (Helmkamp, 1990). The essence of the full costing is that it absorbs the overheads into the unit cost. Each overhead is allocated according to a specific cost center. The full costing method is used to estimate profits as well as valuation of the inventory (Helmkamp, 1990). The major costs involved in the product cost are: Direct Materials: These are the basic raw materials that will be used in the manufacturing of the relevant product. Direct Labor: This represents the total man hours or machine hours that is used directly in the manufacturing of the product such as assembling, acquisitions, etc. Fixed Overheads: These are the expenses that the manufacturing site will incur at zero production such as the rent of the place, depreciation of the equipment, etc. Variable Overhead: This represents the general expenses such as selling and administrative in the manufacturing of the product. The indirect costs such as the overheads are difficult to identify with the relevant good manufactured and therefore pose a problem in the allocation of the costs to the unit product cost. Therefore, specific cost centers are established that help in the precise allocation of these indirect costs. There are three main stages for the allocation of these costs (Helmkamp, 1990): Allocation: In this step, all the costs are collected and allocated to the different cost centers as much as possible. Apportionment: The costs that could not be allocated directly to the cost centers will be distributed amongst the cost centers is done primarily in this step. Absorption: In this step, the absorption rate is established through which the costs are absorbed into the unit cost. The key issue is the ‘fairness’ in the allocation of these costs. Therefore, the main driver of the cost has to be established. The most common used cost drivers are the direct labor hours and machine hours. At times, more than one cost driver can be used to allocate, apportion and absorb the cost into the unit cost (Helmkamp, 1990). In the full costing method, the gross profit is derived from the deduction of the cost of goods sold from the sales. The cost of goods sold includes all the relevant direct costs incurred in the manufacturing of the products such as the direct materials, direct labor and variable overheads and the allocated part of the fixed overheads. From the gross profit, the selling, general and administrative are subtracted to arrive at the net profit. This approach and the illustrated income statement are the most common amongst the shareholders and other external people for the analysis and information (Helmkamp, 1990). Illustration of simple overhead cost allocation is shown below: The rent of the place is £50,000 and is allocated to different cost centers according to the sales revenue generation. Department Hardware Tools Sales revenue 300,000 100,000 % of Total 75 25 Rent allocation 37,500 12,500 Illustration of simple absorption statement is shown below. XYZ Company Ltd   Absorption Income Statement   For the year ended June 30th 20XX   Sales £200   COGS 120   Gross Profit 80   Less: Selling, General and Administrative   Variable SG&A 15   Fixed SG&A 12 27   Net Profit 53           Activity Based Costing (ABC) In the former times, direct labor and machine hours were considered the prime drivers of the costing. But now a new range of inputs have arrived with the evolvement of globalization, segmentation and more internal services and have become the new cost drivers. Therefore, the allocation of the costs was not accurate. The answer to the problem was a newer method known as the activity based costing. In this method, the costs were allocated according to the extent to which the products and services consumed the time, activities and costs in the manufacturing of that product. This system aligned the costs and the products in a more accurate way. This method assured that the relevant costs were being only allocated. This costing method also does take into consideration the idle capacity but rather only the utilized capacity arriving at a more specific cost of output. Therefore, it allows the managers to take the best decisions about pricing and production levels (Hansen, 2006). There are several steps that need to be followed to arrive at the cost of the product using the ABC method: Indentify the main activities in the organization Identify the relevant cost driver for each major activity Develop the cost center for each activity Allocate the costs of activities to the product according to the utilization of the respective activity Criticism of the ABC The ABC costing method is criticized by many people due to several reasons. One of the basic limitations is that the external reporting still involves the use of traditional absorption costing system. The ABC costing does not follow the generally accepted accounting principles (GAAP) and therefore, cannot be used for annual reports. It is only used for supporting internal decision making. It also increases the workload on the employees as they have to develop two cost reports; one for external use using absorption costing and the other for internal use using ABC costing. At the same time, this costing method requires development of several cost pools based on different drivers and hence, creates the confusion (Hansen, 2006). References Book Hansen, D. R. Mowen, M. M. ( 2006) Managerial Accounting. Cengage Learning Helmkamp, J. G. (1990) Managerial Accounting. Indiana University. Wiley Warren, C. S. Reeve, J. M. (2006) Financial and Managerial Accounting. Cengage Learning Warren, C. S. Reeve, J. M. Duchac, J. (2008) Managerial Accounting. Cengage Learning Website FRC (2010) The Combined code and Associated Guidance. Retrieved on May 7th 2010 from http://www.frc.org.uk/corporate/combinedcode.cfm Gillhams Solicitors. (2005) Types of Companies under the Companies Act UK. Retrieved on May 7th 2010 from http://www.gillhams.com/articles/135.cfm Business Link (2010) Legal structures: the basics. Retrieved on May 7th 2010 from http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1073789612&type=RESOURCES Read More