Page 3 - LILITED LIABILITY COMPANIES - INTERMEDIATE

COMPANY ACCOUNTING SESSION 14

1.1 THE FORMATION OF LIMITED LIABILITY COMPANIES - INTRODUCTION

Businesses (such as sole traders) suffer from certain practical disadvantages, in particular:

(i) restrictions on their size;
(ii) the only capital available to them for expansion is whatever can be provided by the proprietor;
(iii) in addition, any liabilities of the business are ultimately liabilities of the proprietor; if the business
fails, the proprietor will be liable to satisfy the claims of payables from his own private assets.

For these reasons and others many businesses are carried on through the medium of limited liability
companies. The owners (called members or shareholders) of such a company may be very numerous, and
many of them may play no direct part in the management of the company. They may be merely investors
looking for a useful way to employ their capital so as to produce an income for themselves.

The members appoint directors to manage the day-to-day conduct of the business. Directors are
employees or officers of the company and are not necessarily members themselves, though they may be
members also; indeed, in many small companies the directors and the members are the same people. Even
so, you should keep their separate functions distinct in your mind, as they are distinct in law.

A limited company is recognised in law as a separate entity from its owners. A company is able to own
property, enter into contracts, sue and be sued in its own name. It has unlimited liability for any debts it
contracts in its own name, but if its assets are insufficient to satisfy those debts the company's owners do
not have to make good the deficiency. This is what is meant by limited liability: the liability of the members
is limited to any amounts they may have contributed to the company as capital. They do not have to dig
any further into their private resources to meet liabilities of the company. This is quite different from the
case of a sole trader.

There is a price to be paid for the benefits of limited liability. To prevent abuse, the activities of limited
companies are much more closely regulated than those of sole traders. For our present purposes, the most
important regulations are those relating to company accounts. Limited companies are obliged to prepare
annual accounts, the format and content of which are prescribed in detail by IAS 1 – presentation of
financial statements. The accounts must be audited by an independent person and they must be published;
this means that a copy must be delivered to the Registrar of Companies and is available for inspection by
any member of the public.

©LAWRENCE CAUCHI AIPFM, LMLCC, FIAB, MAAT, MIAAP. Page 2 of 19