Similar to how a partnership will have an appropriation account, Limited Liability Companies have their own version of Appropriation Account too. The appropriation account shows how the net profits are to be appropriated (how the profits are to be used). Also, similar to partnership account, you will only open appropriation account after your Profit and Loss statement.
The format for company’s appropriation account is shown below, a reminder that this format is to be followed strictly! Failure to do so will make you lose quite a lot of marks! (This is a slightly complicated point to explain in a single post, will aim to explain more in the next post which is relevant to ‘A’ level but extremely beneficial if you understand them too.)
Note 1: Corporation Tax can be calculated using the following formula,
Corporation Tax = Profit before Tax x Tax Rate
So for the above example, if the tax rate is 20%, then the Corporation Tax = 20,000 x 20% = $4,000.
Note 2: Preference Dividend can be calculated based on the following formula,
Preference Dividend = No of shares in Preference Div. x % rate of dividend (pre-agreed)
When shareholders subscribed for preference shares, the % rate of dividend is pre-agreed (say 3%). This is not the same as ordinary shares, the % rate of dividend usually changes according to the performance of the company. So here is an important point, when calculating for preference dividend, the % rate of dividend does not change, and you can usually get this number very easily from the balance sheet.
Note 3: Ordinary Dividend can be calculated based on the following formula:
Ordinary Dividend = No of shares in Ordinary Div. x % rate of dividend
As explained earlier, the % rate of dividend is not pre-agreed, you should find them in the notes to financial statements, stating what is the % rate of dividend. You need to remember that if this is an interim dividend (six months only) then you need to divide it by 2! Refer to previous topic to know why.
More explanation on ‘A’ Level accounting in the next topic for Ordinary Dividend.
Note 4: Profits leftover are called retained profits. You will rarely see an exam question which test you on a company that just start-up. Exam questions will usually test you on subsequent years of operations so you will definitely need to remember to add your retained profits from last year.
Note 5: Transfers to reserves are something that a company wanted to keep for the future, for example: to replace for fixed assets in the future. You will need to remember that transfers to reserves must be shown in between profit after tax and proposed dividend.
Important Note: Proposed dividend refers to end of year dividend and is only a proposal, i.e. there is no cash payment yet. You will need to watch out for this trap. Because there is no cash payment, you will need to credit your creditors account to show that you owe the shareholders their dividend payments. The double entry is as shown below:
Summary: Get the format and reminders right!
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