When preparing final accounts for a business, one important topic that often confuses people is legal charges. These charges are not just legal fees or penalties. They have a specific meaning in accounting and finance. In this blog, we will explain what legal charges are, why they are important, and how they are shown in the final accounts of a business.
We’ll keep everything simple and easy to understand. Whether you are a student, small business owner, or just someone curious about accounting, this blog is for you.
What Are Legal Charges?
Legal charges refer to a financial claim or security created by a lender (such as a bank) over a borrower’s property or asset. This is usually done when the business takes a loan. The lender gets the right to take the property or asset if the borrower fails to repay the loan.
In simple words:
Legal charge = Right over asset given to a lender when a business borrows money.
This is done to secure the loan. The asset is not sold to the bank, but the bank gets the legal right to sell or take it if the loan is not repaid.
Example of Legal Charge
Let’s say a company takes a loan of $100,000 from a bank. To get the loan, the company offers its office building as security. The bank creates a legal charge over that building. This means if the company fails to repay the loan, the bank can sell the building to recover its money.
Types of Legal Charges
There are mainly two types of legal charges:
| Type of Legal Charge | Description |
|---|---|
| Fixed Charge | This is on a specific asset, like land, building, or machinery. The business cannot sell the asset without the lender’s permission. |
| Floating Charge | This is on current assets like stock, debtors, or cash. The business can continue to use and sell these assets in its day-to-day work. The charge becomes fixed only if the business fails to repay the loan. |
Both types are important for securing loans, but how they affect a business’s operations and financial statements can differ.
Where Are Legal Charges Shown in Final Accounts?
In the final accounts, legal charges are not shown directly as an expense. Instead, they are shown in:
- Notes to accounts – Explaining the secured loan and the asset over which the legal charge exists.
- Balance Sheet – The loan is shown under liabilities (Secured Loans), and the asset remains under assets but is now “charged” or “secured.”
- Sometimes mentioned in the Director’s Report or Audit Report as part of loan disclosures.
Why Are Legal Charges Important in Final Accounts?
Legal charges are important because they:
- Show the security status of loans
- Help investors and lenders understand how much of the company’s assets are pledged
- Help auditors and regulators know the risk in the company’s financial structure
- Provide transparency about the company’s obligations and liabilities
When a business has too many legal charges, it may mean the company is heavily dependent on debt, and its assets are tied up.
Legal Charges vs. Legal Expenses
Many people confuse legal charges with legal expenses.
- Legal charges are security rights over assets due to a loan.
- Legal expenses are costs like lawyer fees, court charges, and penalties.
They are not the same. Legal expenses are shown in the Profit & Loss Account, while legal charges are related to Balance Sheet and Loan Details.
Legal Charges in Company Law
Under Company Law, when a company gives a legal charge to a lender, it must register the charge with the Registrar of Companies (RoC). This helps to make the information public and protects the rights of lenders.
If a company fails to register the charge, it can lead to penalties, and the charge may become invalid.
Benefits of Legal Charges for Lenders
Lenders like banks prefer loans with legal charges because:
- They get security for their money.
- They can recover money by selling the asset if needed.
- It reduces their risk.
Because of this, loans with legal charges may have lower interest rates than unsecured loans.
Impact on Business
For the business, offering legal charges can:
- Help get bigger loans
- Build trust with lenders
- Improve creditworthiness
But it also means:
- They cannot freely sell or use the secured asset
- If the business fails, the lender can take the asset
So, it’s important to think carefully before giving legal charges.
Legal Charges – Disclosure in Final Accounts
Businesses must clearly disclose legal charges in their final accounts. This includes:
- Name of the lender
- Amount of the loan
- Asset over which the charge is given
- Type of charge (Fixed or Floating)
- Terms of repayment
This information is often added in the notes to accounts, and it is reviewed during audits.
Real-Life Example
Let’s take the example of a company like Tata Motors. When they take loans to build factories, they often offer land or buildings as security. The bank creates a legal charge over these assets. This charge is mentioned in their financial statements and annual reports.
Public companies must also inform stock exchanges and investors about legal charges, especially if the loan amount is large. You can read more about financial statements on Wikipedia to see how they work.
Legal Charges in Auditing
Auditors must check if:
- All legal charges are properly recorded
- They are registered with authorities
- They match the loan documents
- There is no misuse of secured assets
If there is any doubt, auditors can give a qualified report.
Common Terms Related to Legal Charges
Here’s a table with common terms and what they mean:
| Term | Meaning |
|---|---|
| Secured Loan | Loan with security (asset) offered to lender |
| Mortgage | Legal charge on land or building |
| Hypothecation | Legal charge on movable property (like cars, stock) |
| Debenture | A type of loan instrument that may have legal charges |
| Charge Holder | The person or institution holding the legal charge |
These terms are often found in the notes to accounts of final statements.
Conclusion
Legal charges in final accounts are an important part of a company’s financial structure. They show how loans are secured using the company’s assets. Understanding them helps you know more about the risks, obligations, and true financial position of a business.
They are not just accounting entries, but real legal commitments made by the business. Always check the notes and disclosures in a company’s balance sheet to see if any legal charges exist.
Also Read
- Realisation Account Format
- Motive Power in Final Accounts
- Common Final Accounts Problems and How to Solve Them
- Establishment Expenses in Final Accounts
- Applicability of Accounting Standards
Frequently Asked Questions
What is a legal charge in final accounts?
A legal charge in final accounts is when a lender, like a bank, takes a right over a company’s asset to secure a loan. It means if the company doesn’t pay back the loan, the bank can take or sell the asset to get its money back.
How is a legal charge shown in accounts?
Legal charges are not directly listed as expenses. They are shown as notes in the final accounts. The loan appears under liabilities as a secured loan, and the asset is mentioned as being used as security in the notes to financial statements or reports.
What is the difference between fixed and floating charges?
A fixed charge is tied to a specific asset like land or machinery. The company can’t sell that asset without permission. A floating charge covers assets like stock or cash, which can change daily. It becomes fixed only if the company cannot repay the loan.
Are legal charges and legal expenses the same?
No, they are different. Legal charges are about offering a company’s asset as security for a loan. Legal expenses are lawyer fees or court costs. Legal expenses go in the profit and loss account. Legal charges relate to the balance sheet and loan disclosures.
Why do companies offer legal charges to lenders?
Companies offer legal charges to lenders to get loans. By giving a charge over their property or other assets, they provide security. This helps reduce loan risk for the lender and can also lead to better loan terms, such as lower interest rates or higher loan amounts.
