Additional Notes on Close Corporations (Ccs)

Additional notes on close corporations (CCs)

[Please note that this information is supplementary to section 13.3 in Financial Accounting: An Introduction 3e.] Add 1 Close corporations (CCs)

Shahieda feels that starting a partnership is quite a risky choice, and people have suggested starting a close corporation. A friend mentioned that a close corporation offers more protection to its owners than a partnership or a sole proprietorship, but is less complex and less expensive to form, and easier to administer, than a company. He said that the Close Corporations Act 69 of 1984 created the close corporation as a separate legal person, and the rules and regulations that need to be followed by the close corporation are contained in the Act. One of the similarities between a close corporation and a partnership is that some (if not all) of the owners are usually involved in the management of the corporation. This differs from a company, where the shareholders own the company, while the directors manage the company, although some of the shareholders may also be directors. Close corporations do not issue shares and therefore they have members, not shareholders. Shahieda likes the fact that the owners have an active role in both a partnership and a close corporation, as she is a very “hands-on” type of owner and would not want her business to be managed by someone else.

Did you know? The new Companies Act 71 of 2008, which replaces the existing Companies Act 61 of 1973 (as amended), provides that existing close corporations will be allowed to continue operating as CCs, but no new CCs will be registered from the time that the Act comes into operation. Businesses wanting to have fewer regulations will be registered as limited interest companies, the operations of which will be covered by the Companies Act 71 of 2008. See Chapter 12, Companies for a more detailed description of limited interest companies.

Let’s look at some of the information that Shahieda was able to discover. Add 1.1 Starting a close corporation

Did you know? You have to register a close corporation with the Registrar of Close Corporations before it comes into existence.

In order to register her close corporation, Shahieda will have to reserve a name for her close corporation (on Form CK7). She will also have to submit a founding statement (Form CK1) to the Registrar of Close Corporations. This will have to be signed by each member of the close corporation. The founding statement, which is relatively inexpensive to register, must contain the following information:  The full name of the corporation (Shahieda likes the name “Shahieda’s Laundromat CC”, but is not sure if her cousin will agree)  The principal business of the corporation (dry-cleaning, in the case of Shahieda’s business)  The date of the financial year-end  The full names of the members and their identity numbers  The interest of each member, expressed as a percentage  The particulars of the contribution each member has made to the corporation.

She will also have to get written consent from her accounting officer. She has spoken to a friend, Lindiwe, who has agreed to act as their accounting officer. The accounting officer appointed by a close corporation must be a member of a recognised professional accounting body, such as CIMA, SAICA, CFA or ACIS, but does not need to be a chartered accountant.

Add 1.1.1 What are the responsibilities of the accounting officer?

The responsibilities of the accounting officer are as follows:  To determine whether the financial statements agree with the accounting records  To review the appropriateness of the accounting policies used when drawing up the financial statements  To report to the members of the close corporation on the above matters.

Once the Registrar has registered the founding statement and has issued a Certificate of Incorporation, the close corporation will come into existence. The founding statement replaces the memorandum and articles of association required for a company. Remember that when a partnership is formed it is recommended that the partners draw up a partnership agreement.

Shahieda is unsure who the members are, what is meant by the interest of each member, and what the members can contribute to the close corporation.

Add 1.1.2 Who are the members?

The owners of a close corporation are known as members. In a partnership, the owners are referred to as partners, and in a company they are known as shareholders. A close corporation can have from one to ten members, whereas a partnership can have from two to twenty partners.

Shahieda has been told that only natural persons can become members of a close corporation. We’ll discuss natural persons in detail later in the chapter. Add 1.1.3 What role may each member play?

 The role of an owner

Shahieda and Joseph will want to be rewarded for their investment in the following ways: – A market-related interest rate on the member’s invested capital. The invested capital can be in the form of equity capital, loan capital or a combination of both equity and loan capital. – A salary or fees for services performed for the close corporation – A share of the distributed profit or loss.

The details of these rewards will be agreed on by Shahieda and Joseph and recorded in an association agreement.

It is important to remember that the profit made by the close corporation does not automatically belong to the members. The total profit will not be shared among the members (as with a partnership). The members will need to decide on the amount of profit that will be distributed (in the same way as a company will distribute a dividend). The close corporation will need to ensure that the corporation is solvent and liquid when the distribution is declared and when the distribution is made (review the liquidity and solvency requirements in Chapter 12, Companies). The members are then entitled to their share of the distribution. Shahieda needs to remember that the earnings earned as an owner, which are distributed by the close corporation, are subjected to dividend tax (previously secondary tax on companies (STC)).

 The role of a creditor

Shahieda as a member of the entity may also lend money to the business. A liability is now created in the books of the business as the business in turn, owes the money back to her. The close corporation will reflect this liability as a Loan from member.

 The role of a debtor

Shahieda may fulfil the role of a debtor to the close corporation. This could happen if she borrows money from the close corporation, which she in turn owes back to the business. The close corporation will reflect this asset as a Loan to member.

 The role of an employee

Shahieda as a member of a close corporation can also fulfil the role of an employee. Sometimes members deliver additional services to the close corporation i.e. they may work full-time for the entity or offer additional services over and above the normal duties of the members as specified in the association agreement. In this case the member receives a salary. As this salary is over and above what is agreed upon in the association agreement, these salaries will be recorded as a general salary expense for the close corporation and will be taxable in the hands of the individual member.

Add 1.1.4 What do we mean by the interest of each member?

The interest of each member refers to the percentage ownership that each member has in the close corporation. The contributions by members need not be in the same proportion as the members’ percentage interest. It is the members’ interests, and not their contributions, which determine the proportion in which profits and losses are to be shared.

Add 1.1.5 What do members contribute to the close corporation?

The capital contribution provided by all the members can be in the form of cash and/or assets, and the provision of services in connection with forming the corporation. In a partnership, it is possible for a partner’s contribution to consist of services, knowledge or skills. The contribution of knowledge or skills by any of the partners is recognised in the profit-sharing ratio of the partnership. In the case of a close corporation, the contribution of services will qualify as a contribution only if the services are in connection with the formation of the corporation, for example, legal services, and these may not be in the form of future services, such as future consulting or management services to be provided by the member.

If the amount of a member’s contribution is changed, the details of the increase or decrease in contribution must be made available and a new founding statement will have to be drawn up.

Add 1.1.6 What is a natural person?

We are all natural persons, in that as individuals we have the right to open a bank account, own assets and enter into contracts in our own right. Some legal entities, such as a close corporation or a company, also have the right to open a bank account, own assets and enter into contracts in the name of the close corporation or company.

Close corporations and companies are legal persons but are not natural persons. This means that a company or another close corporation cannot be a member of a close corporation.

Add 1.1.7 Some advantages of a close corporation

Shahieda is interested in the concept of limited liability because she has heard that it is a major advantage when running her business as a close corporation. She has found out that the liability of the members of a close corporation is limited to their investment (capital contribution) in the close corporation. This means that if the close corporation is unable to pay its debts, the maximum that the owners can lose is the amount they have invested in the close corporation as equity (capital).

Definition of limited liability Limited liability can be defined as a member’s liability towards a close corporation (responsibility towards, for example, debts of the business), but which is limited to the investment made (the value of the members’ contribution made) in the entity.

A partnership, on the other hand, has unlimited liability. This means if the partnership is unable to pay its debts, the creditors can claim the personal assets of the owners of the business. The protection offered to members because of limited liability could be lost in certain circumstances, some of which are:  Entering into transactions using the name of the corporation without the abbreviation “CC” to indicate that the business is a close corporation  Failing to make the contributions as stated in the founding statement  Allowing the number of members to exceed ten for a period of six months  Carrying on a business recklessly, with gross negligence, with intent to defraud or for any fraudulent purpose  Making certain payments to members when the corporation does not meet the solvency and liquidity requirements of the Act.

The loss of limited liability will result in members becoming jointly and severally liable for the debts of the corporation. Remember that if members are jointly and severally liable, it means that creditors can claim the personal assets of the members if the close corporation is unable to settle its debts. It also means that if one of the members does not have sufficient personal assets to settle his or her share of the debt, the creditors will take this share from the other members.

Shahieda’s lawyer friend mentioned that although limited liability is an advantage, a number of banks insist on the members of a close corporation signing personal surety when they take out a loan on behalf of the close corporation. If the members sign personal surety and the business is unable to repay its loans, the bank has the right to take the members’ personal assets. Add 1.2 The association agreement

Members of a close corporation will generally draw up an association agreement. This agreement will cover the relationship between the members themselves and between the members and the close corporation. The agreement could cover areas such as:  How profits and losses are distributed (this information is also covered in the founding statement of the close corporation)  What each member’s duties to the corporation are and how much they will be paid  When meetings will be held. Add 1.2.1 Registration with the local authorities

A close corporation needs to register with the local authorities in order to run a business. The registration is the same as for any other local business. A close corporation will need to register with the following bodies:  Regional Services Council  Local municipality  South African Revenue Services (SARS).

The following general principles will apply unless they have been specifically changed by an association agreement:  Every member has the right to participate in the running of the business.  Members have equal rights with regards to the management of the business.  Differences between members will be decided by majority vote.  The number of votes per member corresponds to the percentage interest in the close corporation.  Distributions to the members (by the close corporation) will be in the same proportion as their interest in the close corporation. Add 1.3 Accounting for transactions in a close corporation

Shahieda is concerned that she will have to learn a new set of accounting rules to be able to run a close corporation.

Once the close corporation is established, trading will begin. The daily transactions are recorded in precisely the same manner as for a company, sole proprietor and partnership. The asset, liability, income and expense accounts will be similar whatever the entity form we choose. What will differ dramatically is the way in which we record and disclose equity. We’ll look at this in more detail later in the chapter when we consider Shahieda’s concerns.

Add 1.3.1 Accounting and disclosure requirements

A close corporation is required by section 58 of the Close Corporations Act to prepare the following financial statements within nine months of the end of the financial period:  An income statement (statement of comprehensive income)  A balance sheet (statement of financial position)  Notes to the financial statements  The report from the accounting officer. There are certain requirements relating to companies that are not included in the Close Corporations Act, namely, a directors’ report, the auditor’s report, the preparation of a cash flow statement, and the disclosure of comparative figures (last year’s figures).

Given that the cash flow statement and comparative figures provide information that will be useful to members, it is highly recommended that this information should form part of the annual financial statements of a corporation.

The following additional information must be disclosed in the notes to the financial statements:  Contributions by members  Retained earnings  Revaluations of non current assets  Loans to and from members  Transactions with members.

This information can be presented on a Statement of members’ net investment in the close corporation.

We can see that the only additional financial reports Shahieda will have to draw up if she is operating as a close corporation rather than a sole proprietor are:  The report of the accounting officer  A Statement of members’ net investment in the close corporation.

The Close Corporations Act requires the close corporation to prepare its financial statements in accordance with GAAP. Most, if not all, of the owners are actively involved in the operations of the close corporation, and the close corporation cannot raise equity funding from the general public. The financial statements are therefore not prepared for external users, and close corporations may select to adopt the GAAP standards for SMEs when presenting their financial statements.

Let’s assume that Shahieda decides to start a close corporation with her cousin, Joseph.

Shahieda has decided to keep her other businesses separate from her new venture with her cousin. She will keep the existing business in her own name and has decided to open two new laundromats with him. If they work well together, she will consider bringing the rest of her business into the close corporation.

After a great deal of deliberation, they decide the business will be called Cassiem’s Laundromat CC, and will start trading on 1 July X2.

The founding statement contains the following information:  Shahieda and Joseph’s interests are 80% and 20% respectively.  The members’ contributions are R75 000 from Shahieda (R5 000 in cash and assets valued at R70 000) and R15 000 from Joseph (R1 000 in cash and assets valued at R14 000).

Joseph needs to cash in some of his gold shares to reach the R1 000. He believes that the gold price is going to increase and will reach $360 within the next few months. He has paid only R100 of his contribution up front. He has promised to pay the rest within the next three months. Joseph has also contributed a delivery vehicle (valued at R14 000).

Shahieda has contributed R20 000 in cash, an existing building valued at R50 000, and three industrial machines valued at R20 000. The cash she contributed to the business was in the form of her R5 000 contribution and a loan of R15 000. Something to do 1

1. Prepare the general journal entry to record the initial transactions. 2. Prepare the Statement of financial position as at 1 July X2.

Check your answer 1

1. General journal

Dr Bank 20 000 Cr Member’s contribution 5 000 Cr Long-term loan from members – Shahieda 15 000

Dr Property, plant and equipment 70 000 Cr Member’s contribution 70 000

Dr Short-term loan to member – Joseph 900 Cr Bank 100 Cr Member’s contribution 1 000

Dr Vehicles 14 000 Cr Member’s contribution 14 000 2. Statement of financial position

Cassiem’s Laundromat CC Statement of financial position as at 1 July X2 Total assets Non-current assets 84 000 Property, plant and equipment 70 000 Vehicles 14 000 Current assets 21 000 Cash 20 100 Short-term loans to members 900 Total assets 105 000 Equity and liabilities Members’ interest Members’ contribution 90 000 Liabilities Non-current liabilities Long-term loan from members 15 000 Total equity and liabilities 105 000

Note: The R900 that Joseph owes has been debited to a loan account and credited to members’ contributions. This treatment has been followed because section 24(4) of the Act allows for payment of contributions to be delayed. In terms of the section, outstanding contributions must be paid within 90 days of the date of incorporation.

Joseph’s liability will be limited to the amount of his contribution (R1 000) for 90 days. If he does not pay the outstanding R900 within the 90 days, he will lose his limited liability status and will be liable for every debt of the corporation incurred from 1 July X2 to the date on which he pays the outstanding R900. Add 1.4 How are members of the close corporation rewarded by the business?

Shahieda and Joseph are both involved in the management and operations of the close corporation and have invested capital in the business. They want to be rewarded for this investment in the following ways:  A market-related interest rate on the member’s invested capital. The invested capital can be in the form of equity capital, loan capital or a combination of both equity and loan capital  A salary or fees for services performed for the close corporation  A share of the distributed profit or loss.

The details of these rewards are not automatic and have to be agreed to by Shahieda and Joseph and recorded in an association agreement.

It is important to remember that the profit made by the close corporation does not automatically belong to the members. They will need to decide on the amount of profit that will be distributed. The members are then entitled to their share of the distribution.

Let’s look at each of these in turn.

Add 1.4.1 A market-related interest rate on the members’ invested capital

The invested capital we are referring to includes the member’s contribution and any additional amounts invested by the members to fund the operations of the close corporation. These additional amounts are credited to loan accounts termed members’ loans. In the example above, Shahieda invested an additional R15 000 in the close corporation. This amount was credited to the Long-term loan from members account.

Members of the close corporation do not necessarily share profits in proportion to the capital each has contributed. In this case Shahieda’s interest is 80% and Joseph’s is 20%. This interest is not based on the contribution each has made to the close corporation. The members are compensated, at a market-related rate, for their capital investments. Interest on the capital invested is treated as a normal expense by the close corporation.

Add 1.4.2 Salary to the members

Salaries must be agreed upon by the members according to what members are employed to do in the close corporation. These salaries will be treated as normal operating expenses by the close corporation.

Note: The members of the close corporation will have to pay income tax on the salary and interest received from the close corporation. As discussed below, the close corporation is a separate taxpayer and will have deductions in the form of expenses. Add 1.4.3 Short-term loan accounts

The salaries and interest that members of a close corporation are paid are treated as normal operating expenses, which reduce the profit of the close corporation. If these amounts are paid to members on a monthly basis, the following journal entry will record the payment:

Dr Salaries X Dr Interest X Cr Bank X

The members of the close corporation may choose not to have their salary and interest paid out on a monthly basis. These amounts are owed by the close corporation to the members. A liability account known as Short-term loan from members account is credited. A separate short-term loan account will be opened for each member (when necessary).

If the interest and salaries owed to the members are not paid out on a monthly basis, the following journal entry will be processed:

Dr Salaries X Dr Interest X Cr Short term loan from members – member A X Cr Short term loan from members – member B X

Something to do 2

Shahieda and Joseph have decided to pay a market-related interest of 12% on the members’ invested capital. This interest will be paid only to members whose capital contributions are fully paid up. Joseph has sold some of his gold shares and has paid up his capital contribution. It was decided not to pay any interest on short-term loans from members. Shahieda prefers to have her interest portion paid out to her at the end of each month.

Shahieda has invested the following in the business:

 Member’s contribution of R75 000 (R5 000 + R70 000)  Long-term loan of R15 000

Remember that Shahieda will be paid interest on her member’s contribution and her long-term loan account. Joseph has invested the following in the business:

 Member’s contribution of R15 000 (R1 000 + R14 000)

Prepare the journal entries that are necessary to record these transactions.

Check your answer 2

Dr Bank 900 Cr Member’s contribution 900 Joseph paid up outstanding member’s contribution

Dr Interest on capital 1 050 Cr Bank (R90 000 x 12% x 1/12) 900 Cr Short-term loan from members – Joseph (R15 000 x 12% x 1/12) 150 One month’s interest paid to Shahieda and one month’s interest accruing to Joseph

Shahieda is involved full time in running the business, whereas Joseph is involved in finding appropriate premises and setting up new laundromats where suitable. According to the members’ agreement, Shahieda is paid a monthly salary of R8 000 and Joseph receives a salary of R4 000. Shahieda prefers to be paid on a monthly basis, whereas Joseph prefers to withdraw money owing to him when he needs it.

Prepare the journal entry required to record these transactions.

Check your answer

Dr Salary 12 000 Cr Bank 8 000 Cr Short term loan from members – Joseph 4 000 One month’s salary paid to Shahieda and one month’s salary accruing to Joseph

Add 1.4.4 Taxation

The taxable income of a close corporation is subject to income tax at the same rate as a company (currently 28%). The tax is treated as an expense to the business. Profits distributed to members (dividends) are not taxed in the members’ hands, but, as with a company, the close corporation will need to pay dividend tax of 10% on the distributions (dividends) declared. Did you know? According to the 2008 budget speech, the nature of dividend tax will change. Up until 2009, the tax was an expense of the company. It will change to a withholding tax – which implies that the company will deduct the tax from the cash paid to shareholders, but it is really a tax of the shareholders.

Add 1.4.5 Sharing the profits or losses

A portion of the profit for the period of the close corporation (after tax) is distributed between the members. The amount to be distributed is agreed on by the members at a special meeting, and is shared according to the interest that each member has in the close corporation. It is important to note that the profit of the close corporation does not automatically belong to the members; it belongs to the close corporation itself. This differs from a sole proprietor or a partnership, where the owners have the right to withdraw profits from the business.

The profit for the period, or a portion of it, will be distributed to the members only once an amount has been authorised by the members. The amount paid out to the members is known as distributions (dividends) and the profit that is retained by the corporation is known as retained earnings (accumulated profit). This is similar to what would happen in a company. Shareholders are only entitled to dividends once the directors have declared them.

Add 1.4.6 Distribution to members

It is important to remember that members do not have an automatic claim on the retained earnings of the close corporation. The distribution can occur only once the members have made a formal decision to do so. This distribution is in nature similar to a dividend declared by a company. The total distribution of undistributed income in each period should, as is the case with dividends for companies, be disclosed in the financial statements of the corporation. The distribution can occur only if the following conditions are met:  The corporation’s assets, fairly valued, exceed its liabilities, after such payment is made (the close corporation is solvent) (its current assets are greater than its current liabilities).  The corporation is able to pay its debts as they become due in the ordinary course of its business for a period of 12 months after the test (the close corporation is liquid).

These are referred to as the solvency and liquidity requirements.

The following information is available for the year that Cassiem’s Laundromat has been in business:  The business made a profit of R225 000 during the year. This profit was before any of the members’ salaries or interest on contribution had been accounted for.  Interest on capital invested is charged at 12% p.a.  Salary per member: Shahieda R8 000/month and Joseph R4 000/month.  The business needs to provide for taxation amounting to R19 152. The profit calculation for the year (before taking into account the salaries and interest owed to members) is provided below:

Services rendered 350 000 Less expenses: Accounting officer’s remuneration 1 200 Depreciation 12 000 Salaries: Staff 35 000 Consumables 25 000 Delivery expenses 7 000 Repairs and maintenance 5 000 Water and electricity 33 800 Telephone 6 000

Let’s look at how to prepare the required journal entries to record the interest and salary payments to the members. Shahieda has withdrawn both interest and salaries on a monthly basis whereas Joseph has chosen to withdraw either of these when he needs it.

Dr Salary ((8 000 x 12) + (4 000 x 12)) 144 000 Cr Bank 96 000 Cr Short-term loan from members – Joseph 48 000

Dr Interest on capital 12 600 Cr Bank (90 000 (75 + 15) x 12%) 10 800 Cr Short-term loan from members – Joseph 1 800

Simple interest has been used in the example. In practice Joseph would earn compound interest (interest on interest), as the interest earned would have been reinvested.

Shahieda has been paid her salary immediately (we have credited Bank) whereas Joseph has reinvested his into the business until he chooses to withdraw it (we have credited Short-term loan from members).

At the end of the financial year it was authorised that R20 000 of the profit for the year be made available for distribution to the members.

The profit is shared according to the interest that the members have in the business: Shahieda receives 80% and Joseph 20% after the 10% dividend withholding tax has been deducted. In other words, Shahieda will get 80% of R18 000 (R20 000 less dividend tax of R2 000).

Neither Shahieda nor Joseph has withdrawn their share of the profit from the business. Let’s look at how to prepare the closing entries for the business at the end of the year.

Dr Services rendered 350 000 Cr Profit and loss 350 000

Dr Profit and loss 281 600 Cr Accounting officer’s remuneration 1 200 Cr Depreciation (PPE = 9 000, vehicle = 3 000) 12 000 Cr Salaries: Staff 35 000 Cr Consumables 25 000 Cr Delivery expenses 7 000 Cr Repairs and maintenance 5 000 Cr Water and electricity 33 800 Cr Telephone 6 000 Cr Interest expense 12 600 Cr Salary – members 144 000

Dr Taxation expense 19 152 Cr SARS (income tax) 19 152

Dr Profit and loss 45 880 Cr Retained profit (350 000 (income) – 281 600 (expenses) – 20 520 (income tax) – 27 880 2 000 dividend tax – 18 000 (distribution)) Cr Distribution payable 18 000

Dr Distribution 20 000 Cr Short-term loan from members – Shahieda (80%) 14 400 Cr Short-term loan from members – Joseph (20%) 3 600 Cr SARS 2 000 Add 1.4.7 Dividend tax

When a distribution of profits is declared and made available to the members, the close corporation has to pay over to SARS dividend tax amounting to 10% of the distribution declared.

The amount of profit available for distribution amounts to R20 000. Dividend tax must be paid over to SARS. The remainder will be shared between the members according to their members’ interest in the close corporation:

Shahieda: R18 000 x 80% = R14 400

Joseph: R18 000 x 20% = R3 600

Joseph was by this time really excited about how well his gold shares were doing, but did not have cash available to purchase more. He withdrew R25 000 from his short-term loan account to purchase additional shares.

Prepare the journal entry that is required to record this entry.

Dr Short-term loan from members – Joseph 25 000 Cr Bank 25 000

Let’s draw up the Statement of comprehensive income for Cassiem’s Laundromat CC for the year ending 31 June X3.

Cassiem’s Laundromat CC Statement of comprehensive income for the year ended 31 June X3 Services rendered 350 000 Less expenses: (281 600) Accounting officer’s remuneration 1 200 Depreciation 12 000 Salaries: Staff 35 000 Salaries: Members 144 000 Consumables 25 000 Delivery expenses 7 000 Repairs and maintenance 5 000 Water and electricity 33 800 Telephone 6 000 Interest to members 12 600 Profit before taxation 68 400 Taxation (19 152) Profit for the year 49 248 Other comprehensive income: Profit on property revaluation 0 Total comprehensive income for the year 49 248

The distribution of profits to members needs to be shown. The information could be presented as below, but in practice it is becoming more common to show the information in a Statement of members’ net investment.

Retained earnings Balance at the beginning of the year 0 Total comprehensive income for the year 49 248 Distributions to members (20 000) Retained earnings at the end of the year 29 248 Add 1.5 Revaluation of non-current assets

A new shopping centre has been built across the road from the laundromat, which has increased the value of surrounding business properties. It has been decided to revalue the land and building from R50 000 to R70 000. Something to do 3

Prepare the journal entry to record the transaction relating to the revaluation of the land and buildings.

Check your answer 3

Dr Property, plant and equipment 20 000 Cr Revaluation surplus 20 000

It is important to remember that the revaluation is included in the other comprehensive income section of the statement comprehensive income. The profit on property valuation is recognised as other comprehensive income on the Statement of comprehensive income: Cassiem’s Laundromat CC Statement of comprehensive income for the year ended 31 June X3 Profit for the year 49 248 Other comprehensive income: Gain on property revaluation 20 000 Total comprehensive income for the year 69 248

Something to do 4

Use the additional information below as well as the information already recorded with respect to Cassiem’s Laundromat CC to draw up the Statement of financial position as at 30 June X3, the end of the financial year.

During the year Cassiem’s Laundromat CC had purchased new machinery at a cost of R42 000 and on 1 June they purchased a second delivery vehicle for R45 000. The Trade Receivables balance at the end of the year amounted to R13 400 and the business had R25 800 in the bank. Land and buildings are not depreciated.

Check your answer 4

Cassiem’s Laundromat CC Statement of financial position as at 30 June X3 Total assets Non-current assets 179 000 Property, plant and equipment (70 000 (50+20) + 62 000 (20+42) – 9 000 (depreciation)) 123 000 Vehicles (14 000 + 45 000 – 3 000 (depreciation)) 56 000 Current assets 39 200 Trade receivables 13 400 Cash and cash equivalents 25 800 Total assets 218 200 Equity and liabilities Members’ interest 139 248 Members’ contribution 90 000 Retained earnings 29 248 Revaluation surplus 20 000 Liabilities Non-current liabilities 15 000 Long term loans from members 15 000 Current liabilities 63 952 Short-term loan from members 42 800 SARS 21 152 Total equity and liabilities 218 200

We can see that only the total amount of short-term loans is shown in the Statement of financial position above. In practice, it is becoming more common to show the information in a Statement of members’ net investment, as shown below.

The detail may also be shown in a note on the Movement in loans to and from members. Statement of members’ net investment for the year ended 30 June X3 Total Loans Loans Total Members’ Retained Revaluation members’ from to members’ contributions earnings surplus interest members members investment Balance at the beginning of the year 90 000 – – 90 000 – 90 000 Contributions by members –- Total comprehensive income for the year 47 248 20 000 67 248 67 248 Distributions to members (18 000) (18 000) (18 000) Additional loan granted 67 800 67 800 Payment of loans (25 000) (25 000) Balance at the end of the year 90 000 29 248 20 000 139 248 42 800 182 048

Short-term loans from members Shahieda Joseph Balance at beginning of year 0 0 Amounts transferred in 14 400 53 400* Amounts repaid 0 (25 000) Balance at the end of the year 14 400 28 400 * 48 000 + 1 800 + 3 600 Add 1.5.1 Loans to members

As with a company, a close corporation is a legal person in its own right. In other words, the close corporation and the owners are separate legal entities. This means that all the transactions between the members and the close corporation must be separately disclosed.

We have already seen that the members of a close corporation can lend the corporation money. This will appear on the Statement of financial position as a liability. If the members earn interest, salaries or distributed profit which have not been withdrawn from the business, these amounts appear as a current liability on the Statement of financial position, and are known as Members’ short-term loan accounts.

We have seen that members can lend money to the close corporation and are seen as creditors of the close corporation. The close corporation can also lend money to the members, and in this case, the members will be seen as debtors of the corporation.

Loans to and from members need to be separately disclosed. If the amounts will be repaid in the short term, they should be disclosed as current assets or current liabilities. If these loans are long term in nature, they should be disclosed as non-current assets or non-current liabilities.

Add 1.5.2 Statement of transactions with members

In order to provide members of the close corporation with useful information, a Statement of transactions with members is provided. This statement includes all the transactions with individual members included in the Statement of comprehensive income above in arriving at the net income. These transactions include: salaries accruing to members, interest accruing to members, and distributions of profit accruing to members. Something to do 5

Prepare the Statement of transactions with members for Cassiem’s Laundromat as at 30 June X3.

Check your answer 5

Cassiem’s Laundromat Statement of transactions with members as at 30 June X3 Shahieda Joseph Members’ salaries 96 000 48 000 Members’ interest on capital 10 800 1 800 Distribution of profit 14 400 3 600 Some points about this example  The recording and reporting process in a close corporation is exactly the same as for a sole proprietor, partnership or company.  All the concepts, principles, and the recording and reporting process that you have learnt in the textbook up to now apply as much to close corporations as they do to any other business entity.  The equity section of each entity will differ. The equity section of a close corporation is referred to as members’ funds. The members’ funds will include: members’ contributions, surplus on revaluation of land, and retained earnings.  Close corporations can make loans to or from members. These loans should be separately disclosed on the Statement of financial position as either assets or liabilities.

Summary of close corporations

 The owners are separate from the close corporation and have limited liability.  The format of the Capital account is different from those of a sole proprietor and a partnership; members’ accounts are grouped together and collectively known as “members’ contributions”.  The profits of the close corporation do not automatically accrue to the members.  The salary, interest on capital contribution and profit distribution accruing to the members is recorded in the Short-term loan to members’ account.  The undistributed profit remains in the close corporation as “retained earnings”.  There are liquidity requirements that have to be met before profits can be distributed.  Members can lend money to or borrow from the close corporation. This information needs to be separately disclosed.  There are instances where members can lose their limited liability.