FAQ: How does a company Repay a Shareholders Advance?

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Question: From my understanding, considering the company was initially funded by owner funds of $50K put into the company, it should be possible to take owner funds out from revenue earned up to this amount. Is this correct?

Shareholder Current Account

How Funds are Credited

It is common when a company begins operation for the shareholder(s): –

  • To pay up the share capital, for the purpose of this exercise we’ll say it is $120 being for 120 Fully Paid-up $1.00 Shares, and
  • To also advance needed capital so that the company can start operating and for the purpose of this exercise we’ll say it is $50,000. This is commonly referred to as Working Capital.

Let’s look at how this is recorded in the company accounting system. It is essential that the $50,120 be deposited into the company’s bank account. The $120 is coded to the Paid up Share Capital Account and the $50,000 is coded to the Shareholder Current Account, which essentially records any loans either to or from the company.

This is how it would look in the Bank Account:

Payments Receipts
Initial Paid up Capital & Shareholders Advance $50,120
Balance $50,120    

 

This is how it would look in the Balance Sheet:

Assets Liabilities
Bank $50,120 Shareholders Current Account $50,000
Capital
Paid up Share Capital $120
Totals $50,120   $50,120

 

This loan to the company at the beginning is the opening entry in the Shareholder Current Account. During the life of the company, dividends or shareholder salaries declared to the shareholder can increase the current account. The current account can be reduced by drawings from the company.

It can be seen that at this point providing there is $50,000 in the Bank Account the Shareholders Advance of $50,000 can be repaid. However it is not the intention to repay this at this point in time as the $50,000 was advanced so that the company could start operating. So let’s move on.

Day to Day Operation

During the normal day to day operation the business receives income from Sales/ Services, which is deposited into the bank account, pays expenses out of the bank account and is left with a balance.

For the purpose of this exercise we will assume the following for a twelve (12) month period:

  • Sales = $280,000 (GST Inclusive)
  • Expenses = $82,500 (GST Inclusive)
  • GST = $30,000
  • Profit Before Taxation = $167,500

This is how it would look in the Bank Account:

Payments Receipts
Operating Expenses $82,500 Initial Paid up Capital & Shareholders Advance $50,120
GST Payment $30,000 Sales $280,000
Balance $217,620    

 

This is how it would look in the Profit & Loss (P&L) Account:

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Profit Before Taxation $167,500

 

This is how it would look in the Balance Sheet:

Assets Liabilities
Bank Account $217,620 Shareholders Current Account $50,000
Capital
Paid up Share Capital $120
Profit Before Taxation $167,500
Totals $217,620   $217,620

 

At this point there is tax to be paid on the $167,500 Profit before Taxation. This can be done one of three ways:

  • Firstly, the company can pay tax, currently at 28c in the dollar, on this amount. This would be $46,900.

This is how it would look in the P&L Account:

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Profit Before Taxation $167,500
Less Tax ($46,900)
Profit After Taxation $120,600

 

 This is how it would look in the Balance Sheet:

Assets Liabilities
Bank Account $217,620 Shareholders Current Account $50,000
Taxation to Pay $46,900
Capital
Paid up Share Capital $120
Current Years Profit After Taxation $120,600
Retained Earnings $0
Totals $217,620   $217,620

 

  • Secondly, the total amount of $167,500 can be paid as Shareholder Salary, which will form part of the Shareholder’s personal taxable income and taxed at their personal tax rate. The amount of $167,500 is Debited in the Profit & Loss (P&L) Account and Credited to the Shareholders Current Account in the Balance Sheet.

This is how it would look in the P&L Account:

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Shareholder Salary $167,500

 

This is how it would look in the Balance Sheet:

Assets Liabilities
Bank Account $217,620 Shareholder Current Account:
Initial Advance $50,000
Salary Credited $167,500
Drawings Debited $0
Current Account Balance $217,500
Capital
Paid up Share Capital $120
Current Years Profit After Taxation $0
Retained Earnings $0
Totals $217,620   $217,620

 

  • Thirdly, part of the total amount of $167,500 can be paid as Shareholder Salary, which will form part of the Shareholder’s personal taxable income and taxed at their personal tax rate. The remainder being taxed at the company tax rate which is currently at 28c in the dollar.

Shareholder Current Account

How Funds are Debited

You will note that up to this point we have only focused on how funds are credited to the Shareholder Current Account and we have not dealt with how the shareholder gets funds out of the Shareholder Current Account.

Drawings

Firstly, a common concept that is misunderstood by business owners is the concept of drawings.

In its simplest form, cash taken from the business for personal use is classed as drawings.  Drawings are not a tax-deductible expense of the business.

As a shareholder (if you are not already receiving a PAYE salary or wage) you may take drawings in lieu of wages during the year out of the profits of the business, then when the annual accounts are completed and the company’s profit is determined, a salary will need to be paid to cover any drawings.  The shareholder will be liable for tax on this amount in their personal income tax return.

Let us again look at the scenario above where we debited the amount of $167,500 of Shareholder Salary in the P&L Account and credited it to the Shareholders Current Account in the Balance Sheet.

This is how it looks in the P&L Account:

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Shareholder Salary $167,500

 

This is how it looks in the Balance Sheet:

Assets Liabilities
Bank Account $217,620 Shareholder Current Account:
Initial Advance $50,000
Salary Credited $167,500
Drawings Debited $0
Current Account Balance $217,500
Capital
Paid up Share Capital $120
Current Years Profit After Taxation $0
Retained Earnings $0
Totals $217,620   $217,620

 

You will note that at this stage we have not allocated any Drawings. For this scenario let us say that the owner regularly took Drawings in Lieu of Wages and over the Financial Year that totalled $167,500.

This is how it would look in the Bank Account:

Payments Receipts
Operating Expenses $82,500 Initial Paid up Capital & Shareholders Advance $50,120
GST Payment $30,000 Sales $280,000
Shareholder Drawings $167,500
Balance $50,120    

 

This is how it would look in the P&L Account: No Change

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Shareholder Salary $167,500


This is how it would look in the Balance Sheet:

Assets Liabilities
Bank Account $50,120 Shareholder Current Account:
Initial Advance $50,000
Salary Credited $167,500
Drawings Debited $167,500
Current Account Balance $50,000
Capital
Paid up Share Capital $120
Current Years Profit After Taxation $0
Retained Earnings $0
Totals $50,120   $50,120

 

You will note at this stage, providing the Company had no other financial obligations the Company could repay all or some of the initial $50,000 Shareholder advance. Alternatively, in the above scenario, the Company could have repaid the initial $50,000 Shareholder advance and $117,500 a total of $167,500. This would still leave a $50,000 Current Account Balance.

This is how it would look in the Bank Account:

Payments Receipts
Operating Expenses $82,500 Initial Paid up Capital & Shareholders Advance $50,120
GST Payment $30,000 Sales $280,000
Shareholder Drawings $117,500
Initial Advance Repaid $50,000
Balance $50,120    

 

This is how it looks in the P&L Account: No Change

Payments Receipts
Operating Expenses $75,000 Sales $242,500
Shareholder Salary $167,500

 

This is how it looks in the Balance Sheet:

Assets Liabilities
Bank Account $50,120 Shareholder Current Account:
Initial Advance $0
Salary Credited $167,500
Drawings Debited $117,500
Current Account Balance $50,000
Capital
Paid up Share Capital $120
Current Years Profit After Taxation $0
Retained Earnings $0
Totals $50,120   $50,120

 

Remember, the shareholder will be liable for the tax on Shareholder Salary, of $167,500, debited in the P&L and credited to the Shareholder Current Account. The $167,500 must be declared in the Shareholders personal income tax return relating to the year the Shareholder Salary was deducted, e.g. 31st March 2015. The Tax on $167,500 could between $46,195.00 and $55,275 depending on the Shareholders Tax Rate. So as can be seen provision must be made towards the payment of this tax so as to avoid Late Tax Payment Penalties and Use of Money Interest. To this end we have written an article titled “The Simple way to save for business taxes”.

Overdrawn Current Account

Care must be taken not to take more in drawings than the company is making.   This may leave the Shareholder in the position of having an overdrawn current account where either Fringe Benefit Tax (FBT) is payable or the company must charge the Shareholder interest, which is taxable income to the company at 28 cents and not a tax deductible expense to the shareholder.

In our experience this is a confusing discussion point with many business owners, who see their drawings from the business as wages.  They are only wages, if a salary is declared and paid from the company’s profit.  However, if the company did not make any profit, it is not in a position to pay a salary and the Shareholder will end up with an overdrawn current account.

There a three ways to fix an overdrawn current account: –

  • Firstly, is for the Shareholder to repay the loan from the company – that is put the money back,
  • Secondly, is that the company needs to earn a profit to allow an increased shareholder salary to be paid, and
  • Thirdly, by the Company Declaring a Dividend. However, this will be limited to any retained earnings or past capital gains. Also the company must be solvent both before and after a dividend or shareholder salary is declared.

Important Note: We have made a lot of assumptions in preparing this article and have for simplicity based everything on a twelve month period. In reality, as you well know, all transactions happen on a day to day basis.

Thank you for taking the time to read this. I trust that the above has been informative and if you want advice on your specific situation or you have any questions please contact us.

Disclaimer: This publication has been carefully prepared, but it has been written in general terms only. The publication should not be relied upon to provide specific information without also obtaining appropriate professional advice after detailed examination of your particular situation.

 

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