Divisible Profits & Dividends Bcom Notes

Divisible Profits & Dividends Bcom Notes

Divisible Profits & Dividends Bcom Notes:- In this post, I am giving you the notes of Bcom 3rd Year auditing, which is going to be very useful in your examination and you should share this post to all friends and all your groups so that your friends also read this post. Could. Divisible Profits & Dividends


Divisible Profits & Dividends

Meaning of Divisible Profits

The primary objective of running any business undertaking is to earn profits and to distribute the same amongst its shareholders. But all the profits of a company are not divisible to its shareholders. Only those profits which can be legally distributed in the form of dividend to the shareholders of the company are called as ‘Divisible Profits’. There is no definition of the term ‘divisible profit’ in the Companies Act. At the same time, law still does not lay down the meaning of profit. It also does not say that only true profits can be distributed. However, Section 205 of the Companies Act, which deals with the question of dividends, provides that no dividend may be declared or paid except out of the profits of the company arrived at after providing for depreciation in the manner prescribed in this behalfunder the Act.

Thus, it becomes clear that there is no clear cut definition of the ‘divisible profit’ however in some legal decisions it can be defined as follows:

According to the decision in the case of Fisher Vs. Black and White Publishing Company (1901), “Divisible profits were considered as net profits available for dividends after making, deductions which the directors of a company can duly make.”

Divisible Profits & Dividends

Provisions Regarding Divisible Profits

The following considerations must be followed for determining the amount that can be legally distributed as dividend. These can be categorised as follows:

  1. Provisions of the Companies Act.
  2. Provisions of Table ‘A’.

III. Memorandum and Articles of Association.

  1. Principles of Accountancy.


(I) Provisions of the Companies Act

 Section 205 of the Companies Act lays down provisions relating to the distribution of profit. The main provisions can be summarised as follows:

(1) Dividend is declared out of current profits: Dividend may be declared out of profits of the company for the current year after providing for depreciation in accordance with the provisions of section 205 (2). Dividend can also be declared out of the undistributed profits of the previous financial years after providing depreciation and in accordance with the rules prescribed by the Central Government.

(2) Transfer to Reserves: A company is required to transfer a prescribed percentage of its profits (not exceeding 10 percent) to its reserves before declaring dividends.

(3) Payment of dividend to be in cash: According to section 205 (3) dividend must be paid in cash or by cheque or warrant except when the company decides to capitalise profits or reserves by the issue of bonus shares or paying up any amount, which is for the time being unpaid on any shares held by the shareholders.

(4) Dividend is paid only to registered shareholders: Under Sec. 206, dividend in respect of any share shall be paid by a company: (a) to a registered holder of such share, or to his order, or to his banker; or (b) in the case of a share warrant issued in respect of the share in pursuance of Sec. 114, to the bearer of such warrant or to his bankers.

(5) Payment of dividend within 30 days: The company must pay dividend to the shareholders within 30 days of declaration of the dividend.

(6) Transfer of unpaid dividend to a special dividend account: A company must transfer the unpaid dividend within 7 days after the expiry of 30 days of the declaration of the dividend to a special account called unpaid dividend a/c of …… Co. Ltd. or Private) Ltd. in a Scheduled Bank. If the amount is not transferred, ( the company shall pay interest at the rate of 18% per annum.


(II) Provisions of Table ‘A’

Table ‘A’ of the Companies, Act also lays down the provisions of the Articles in respect of procedure for payment of dividend as follows:


(1) Declaration of dividend in the general meeting:

A company may declare a dividend in a general meeting but the dividend to be declared should not exceed the amount recommended by the Board of Directors of the Company.

(2) Declaration of interim dividend: Table ‘A’ allows the Board of Directors to pay interim dividend as appear to be justified by the profits of the company.

(3) Payment of dividend in proportion of their paid-up amount: A company has to pay dividends proportionate to the amount paid-up on each share. Therefore, shareholders with a larger paid-up amount will get dividends proportionate to their contribution. But no dividend is paid on the amount received in advance on shares.

(4) Adjustment of arrears payable by members out of dividends: The Board may deduct from any dividend payable to any member all sums of money, if any, presently payable by him to the company on account of calls, etc.

(5) Notice of declaration of dividend: A Notice of any dividend that may have been declared shall be given to the persons entitled to share therein in the manner mentioned in the Act.

(6) No interest on dividend arrears: No dividend arrears shall bear interest against the company.


(III) Provisions of Memorandum and Articles

The company’s Memorandum and Articles of Association must also be complied along with provisions of the Companies Act. However, the memorandum and Articles must be subsidiary to the provisions of the Act.

According to F.R.M. de Paula, “In every individual case in practice, the provisions of the Memorandum and Articles of Association of a company are of the utmost importance when considering the question of divisible profits.”


(IV) Principles of Accountancy

According to the principles of accountancy dividend can only be distributed out of profits and the capital of the shareholders cannot be used for this purpose. Provisions for contingent events should also me made before the distribution of profits.

Duties of an Auditor as regards Divisible Profits

The duties of an auditor in connection with divisible profits are summarised as follows:

I. Examination of Memorandum and Articles of Association: The auditor should examine that:

(1) Provisions of Memorandum of Association and Articles of Association along with the directives of different statutes should be properly applied in the proper perspective so that the profits cannot be declared out of capital.

(2) Provisions of Companies Act are followed or not: He must see if the provisions of companies Act, 1956 have been duly observed while declaring or making payment of dividends.

(3) Computation of dividend: Dividend can only be distributed out of profits and the capital of the shareholders cannot be used for the purpose. He should ascertain whether profits earmarked for the purpose of dividend have been computed in accordance with the requirements of Sec. 205 of the Companies Act.

(4) Study of resolution related to dividend: Company Auditor should study carefully the relevant resolutions related to the dividend distribution through the Minutes Books of Board Meetings and Annual General Meeting of the Members. He has to make sure that there are no procedural lapses in the declaration of dividends.

(5) Verification of Payment of dividend: To verify the correct calculation and computation of the amount proposed to be paid to individual shareholders, the dividend lists should be checked with the Members’ Registers. Later on the payments should be checked with the bank statement to find out the names of the persons who did not claim dividend up to the end of the financial year.

(6) Verification of Unclaimed dividend: The amount of unclaimed dividend should be verified with the Dividend Account, Bank Pass Book, and dividend warrants as have been returned undelivered.

(7) Provision for depreciation: It should be seen that depreciation in respect of fixed assets (as also floating assets) has been provided before computation of divisible profits.

(8) Payment of dividend through bonus shares: In case of dividend payment by way of issue of bonus shares, it should be ascertained whether it is within the limits of unissued capital and whether the Articles of the company authorise it.

Thus auditor should carefully watch the interests of the company in the disbursement and declaration of dividends. If he has any doubt that Articles, provision of Companies Act and statutory requirements are not followed in regards with divisible profits, he should mention this fact in his report.

Divisible Profits & Dividends

Meaning of Capital Profits

Profits which are not earned through trading, manufacturing or other business operations are called capital profits. In other words, non-trading profits are capital profits. Such profits do not arise in the normal course of the business. For example, profit made on sale of a fixed asset, premium received on issue of shares, profits made on the re-sale of forfeited shares and profits made on the redemption of debentures in the open market etc. From these examples, it is clear, that such profits are not earned in the regular course of business. Normally, such profits should not be distributed amongst shareholders as dividends; but in certain circumstances, capital profits can also be distributed among the shareholders of the company. Some selected references of the leading cases on the point of capital profits are summarised as under:

(i) Lubbock vs the British Bank of South America Ltd. (1892): In this case it was held that the company may declare dividend out of profits made on the sale of a part of the undertaking if the Articles of Association of the company so permit.

(ii) Foster vs. the New Trinidad Lake Asphalate Company Ltd. (1901): In this case, it was held that capital profits cannot be distributed unless

(a) all the other assets had been revalued,

(b) such profits had been actually realised and

(c) the Articles of Association of the company has permitted such distribution.

Rules Regarding Distribution of Capital Profits Main conditions regarding distribution of dividend out of capital profits are as follows:

(1) Issue of Bonus Shares out of Capital Profits: Generally capital profits can be distributed in the form of bonus shares because it does not reduce the value of assets. It is applicable only regarding Premium received on shares’ and ‘Capital Redemption Reserve’.

(2) Cash Dividend: The following conditions must be fulfilled before distributing capital profits in the cash dividend.

(i) The Articles of the Company do not prohibit such distribution.

(ii) The capital profit should have been realised.

(iii) If capital profits have not transferred to the Capital Reserve Account by the directors.

(iv) All the capital losses have been met and their distributions to the share holders does not affect the payment of the debts of the Company.

(v) The surplus profits remain even after the revalution of all the assets and liabilities of the company.

Divisible Profits & Dividends

Capital Profits which cannot be Distributed as Dividend

Following types of capital profits cannot be distributed as dividend in any case:

(1) Profit prior to incorporation of a company: Profits prior to incorporation of the company cannot be distributed among the shareholders. The reason is that the company had not come into existence when such profits were earned and therefore shareholders have no right to share such profits.

(2) Premium received on issue of shares: According to section 78 of the Companies Act, premium received on issue of shares can not be distributed as dividend. This amount can only be used to write off the capital losses or to issue the bonus shares.

(3) Capital profit from forfeiting shares: On the issue of forfeited shares if there exists any balance in the forfeiture account, it can not be distributed as dividends.

Divisible Profits & Dividends

Capital Profits and Auditor

Upto what extent capital profits are distributed as dividend, an auditor should see the following points:

(1) The auditor should see the Articles of the Company that upto what extent capital profits can be distributed as dividends.

(2) The auditor should examine whether judgements of courts are followed or not in the distribution of capital profits.

(3) When company distribute the capital profits as dividend, the auditor should mention this fact in his report.

(4) The auditor should see that capital profits which are distributed as dividends are computed accurately or not.

(5) The auditor should see that profit prior to incorporation of the company cannot be distributed among the shareholders.

(6) The Auditor should see that premium received on issue of shares can not be distributed as dividends.

Divisible Profits & Dividends

Distribution of Dividends out of Capital

Dividends can never be paid out of capital. Even if it is contained in the Articles of Association, such provision would be ultravires. It is expected that by all means the original capital contributed by the shareholders must be kept intact, because if the dividends are paid out of capital, it would result into depletion of assets of the company. This would leave the creditors helpless on account of reduction in the security which they hold over the assets.

The dividend payment from capital will decrease the amount of capital which is against section 100 of the Companies Act, 1956. Unless it is permitted by the court and certain formalities are observed. Dividend assumed to be distributed out of capital.

  1. Payment of dividend out of sale proceeds of the company’s assets. i.e., out of capital receipts.
  2. Payment of dividend out of overstated profits in case of revenue expenditure charged to capital expenditure.
  3. Profit and Loss account do not deal with any profit and there are no undistributed past profits, but the dividends are proposed to be paid. Payment of dividends out of capital would result into depletion of assets of the company which is never permissible.

Divisible Profits & Dividends

Restrictions on the payment of Dividend out of Capital

The basic principle is that dividend can never be paid out of the capital. The provisions of Companies Act also subscribe to it. The following are the reasons of the restrictions imposed on the payment of dividend out of capital.

  1. It is Illegal: If dividends are paid out of capital, it would result into depletion of assets of the company. According to section 100 of the Companies Act, 1956 no company can reduce its capital without the permission of the Court. That it why the distribution of dividend out of capital is illegal.
  2. Dangerous to the security of the creditors: Distribution of dividend out of capital is a serious danger to the security of the creditors and debenture-holders of the company because they agree to deal with a company only on the basis of the capital of the company. The company holds the limited liability and therefore, reduction of capital amounts to reduction in their security.
  3. Prohibited by Law: According to the 9th Article of ‘Table A’ dividend can not be distributed out of capital. If the Memorandum of Association or its Articles give such power to the company such power is invalid.
  4. Liability of Directors: Even if the directors of the company have distributed dividends out of capital, they will be personally liable to return the money to the company alongwith the interest at the rate of 5% per annum.
  5. Possibilities of Fraud: Fraudulent promoters may cheat the public by taking big loans and later on take back their capital in the form of dividends. Thus the money lenders are put to a great loss.

Divisible Profits & Dividends

Divisible Profits & Dividends Bcom Notes
Divisible Profits & Dividends Bcom Notes

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