Chapter 8 - Divisible Profit
* Divisible Profit
* Concept of Profit
* Principles of Divisible Profit
* Importance of Correct Profit
* Secret Reserves
* How Secret Reserves is Created
* Advantages of Secret Reserves
* Divisible Profit
* Concept of Profit
* Principles of Divisible Profit
* Importance of Correct Profit
* Secret Reserves
* How Secret Reserves is Created
* Advantages of Secret Reserves
Introduction of Divisible Profit
Those profits are term as the divisible profit, which is legally distributed to the shareholders of a company as dividend.
Factors of Divisible Profit
The following are the main factors, which influence the divisible profit.
1. Capital Profit
The divisible profit ca be paid, if there is some capital profit or gain.
2. Capital Loss
If some part of the capital is lost or there is capital loss the dividend can be paid out of the current profits without making any provisions for any capital loss.
3. Depreciation
The depreciation is charged before the distribution of the divisible profit
4. Transfers of Reserves
Under company ordinance 1984,
Before declaring dividends the directors have powers to make such reserves as they may think proper.
Concept of Profit
Like the term "value" in economics accountants have used the word. "Profit" for many years without assigning a definite meaning to it. This state affairs has given rise to much informed criticism of accountants and their work added to this is the difficulty caused by the divergence that exists in the concept of the profit between the economist and an accountant for the purpose of settlement of claims of parties to their shares in the profit of a business.
Principles of Divisible Profit
1. Articles of Association
The articles of associations are the rules of the company for managing the business activities. The articles prescribe the rules for divisible profit. The directors are entitled to distribute the profits under the rules. The cannot exceed the prescribed limits.
2. Companies Ordinance
The companies ordinance 1984 states the rules and regulation for distribution of the profits to the shareholders. The dividend can be paid out of revenue profit. The directors must follow the rules of companies for distributing profits. They cannot violate the law.
3. Accountancy Principle
The accountancy principles must be followed for calculating the divisible profits. The going concern, consistency, conservation matching concepts is applied. These principles must be applied other wise the reliable result cannot be expected from the accounting books and records.
4. Legal Decision
The legal decision must be kept in mind which calculating the divisible profits. The court cases relating to auditing must be followed if applicable to the conditions of business. The auditor must know the decision announced by the courts from time to time.
5. Capital Maintenance
The principles of capital maintenance must be applied. The capital cannot be used to pay dividend. The revenue profits can be utilized for payments of dividend. The capital account must remain intact. It is illegal it the directors pay dividend out of capital during any year.
6. Shareholders Approval
The divisible profits can be used to pay as dividend after approval of shareholders. The annual general meeting is called and the shareholders approve rate recommended by directors. The rate of dividend proposed cannot be increased at all.
7. Capital Profit
The capital profit can be used to pay dividend under certain conditions. The capital profit should be realized. All the assets should be revalued and even then there is surplus. The articles of association allow the distribution of capital profit as dividend. The depreciation on the revalued assets has been recorded in the books of accounts.
8. Directors Proposal
The directors have the right to propose the rate of dividend under certain conditions. The capital profit should be realized. All the assets should be revalued and even then there is surplus. The articles of association allow the distribution of capital profit as dividend. The depreciation on the revalued assets has been recorded in the books of accounts.
9. Capital Loss
The dividend can be paid out of revenue profits even there is capital loss. There is no need to adjust old capital loss before payment of dividends. The current year revenue profit can used to pay dividend. The capital profit must be used to eliminate capital loss finest and then surplus can be used to pay dividend.
10. Depreciation
The dividend can be paid out revenue profits. The depreciation on fixed assets must be charge to profit and loss before declaring revenue profits. In case of manufacturing company it is compulsory to charge depreciation before declaration of profit or dividend.
11. Past Losses
The company may sustain a loss in one year. It can earn profit in the next year. The company may adjust loss of previous year. The remaining profit of current year can be pay dividends. In 1918, Ammonia Soda Co. V Chamberlain case the court decided that under the articles of association the directors can pay dividend out of current year profit with out adjustment past losses.
12. Transfer to Reserve
The dividend can be paid of revenue profit remaining after transfer to reserves. The articles of association empower the directors to create at a certain rate. In case of banks and financial institutions it is obligatory to set up statutory reserves.
13. Secret Reserves
Management creates the secret reserves by various techniques. The financial institutions need such reserves to develop the confidence of customers and owners. The reserves can be created and used to pay dividend if allowed under the articles. The misuse of such reserves must not be allowed.
14. Undistributed Profit
The directors for declaring dividend can use undistributed profit or profit and loss appropriation balance. It is revenue of the previous years. It is a right of the directors to used such profit for payment of dividend at the end of the year.
15. Profit Prior to Incorporation
The profit prior to incorporation is a capital profit. It cannot be used for payment of dividend. It is a profit earned before the registration of the company. It can be used to write off capital loss or issue of bonus share by the company management.
16. Asset Revaluation
The management can revalue the assets. The surplus on revaluation of assets can be started on liability side of balance sheet. It can be used after realization. The assets may be sold and profit may be realized.
17. Solvency of Company
The solvency of the business is very important than payment of dividend. The management must determine cash needs of the company. If cash is surplus than business requirements then dividend then can be paid is cash. In cash of storage of funds dividend should not be paid in cash.
18. Creditors Protection
It is a principle of divisible profits that dividend must be paid out of revenue profits. The correct calculation is essential for all who depend upon business. The overstatement can disturb one section of investors while understatement can upset another group.
Those profits are term as the divisible profit, which is legally distributed to the shareholders of a company as dividend.
Factors of Divisible Profit
The following are the main factors, which influence the divisible profit.
1. Capital Profit
The divisible profit ca be paid, if there is some capital profit or gain.
2. Capital Loss
If some part of the capital is lost or there is capital loss the dividend can be paid out of the current profits without making any provisions for any capital loss.
3. Depreciation
The depreciation is charged before the distribution of the divisible profit
4. Transfers of Reserves
Under company ordinance 1984,
Before declaring dividends the directors have powers to make such reserves as they may think proper.
Concept of Profit
Like the term "value" in economics accountants have used the word. "Profit" for many years without assigning a definite meaning to it. This state affairs has given rise to much informed criticism of accountants and their work added to this is the difficulty caused by the divergence that exists in the concept of the profit between the economist and an accountant for the purpose of settlement of claims of parties to their shares in the profit of a business.
Principles of Divisible Profit
1. Articles of Association
The articles of associations are the rules of the company for managing the business activities. The articles prescribe the rules for divisible profit. The directors are entitled to distribute the profits under the rules. The cannot exceed the prescribed limits.
2. Companies Ordinance
The companies ordinance 1984 states the rules and regulation for distribution of the profits to the shareholders. The dividend can be paid out of revenue profit. The directors must follow the rules of companies for distributing profits. They cannot violate the law.
3. Accountancy Principle
The accountancy principles must be followed for calculating the divisible profits. The going concern, consistency, conservation matching concepts is applied. These principles must be applied other wise the reliable result cannot be expected from the accounting books and records.
4. Legal Decision
The legal decision must be kept in mind which calculating the divisible profits. The court cases relating to auditing must be followed if applicable to the conditions of business. The auditor must know the decision announced by the courts from time to time.
5. Capital Maintenance
The principles of capital maintenance must be applied. The capital cannot be used to pay dividend. The revenue profits can be utilized for payments of dividend. The capital account must remain intact. It is illegal it the directors pay dividend out of capital during any year.
6. Shareholders Approval
The divisible profits can be used to pay as dividend after approval of shareholders. The annual general meeting is called and the shareholders approve rate recommended by directors. The rate of dividend proposed cannot be increased at all.
7. Capital Profit
The capital profit can be used to pay dividend under certain conditions. The capital profit should be realized. All the assets should be revalued and even then there is surplus. The articles of association allow the distribution of capital profit as dividend. The depreciation on the revalued assets has been recorded in the books of accounts.
8. Directors Proposal
The directors have the right to propose the rate of dividend under certain conditions. The capital profit should be realized. All the assets should be revalued and even then there is surplus. The articles of association allow the distribution of capital profit as dividend. The depreciation on the revalued assets has been recorded in the books of accounts.
9. Capital Loss
The dividend can be paid out of revenue profits even there is capital loss. There is no need to adjust old capital loss before payment of dividends. The current year revenue profit can used to pay dividend. The capital profit must be used to eliminate capital loss finest and then surplus can be used to pay dividend.
10. Depreciation
The dividend can be paid out revenue profits. The depreciation on fixed assets must be charge to profit and loss before declaring revenue profits. In case of manufacturing company it is compulsory to charge depreciation before declaration of profit or dividend.
11. Past Losses
The company may sustain a loss in one year. It can earn profit in the next year. The company may adjust loss of previous year. The remaining profit of current year can be pay dividends. In 1918, Ammonia Soda Co. V Chamberlain case the court decided that under the articles of association the directors can pay dividend out of current year profit with out adjustment past losses.
12. Transfer to Reserve
The dividend can be paid of revenue profit remaining after transfer to reserves. The articles of association empower the directors to create at a certain rate. In case of banks and financial institutions it is obligatory to set up statutory reserves.
13. Secret Reserves
Management creates the secret reserves by various techniques. The financial institutions need such reserves to develop the confidence of customers and owners. The reserves can be created and used to pay dividend if allowed under the articles. The misuse of such reserves must not be allowed.
14. Undistributed Profit
The directors for declaring dividend can use undistributed profit or profit and loss appropriation balance. It is revenue of the previous years. It is a right of the directors to used such profit for payment of dividend at the end of the year.
15. Profit Prior to Incorporation
The profit prior to incorporation is a capital profit. It cannot be used for payment of dividend. It is a profit earned before the registration of the company. It can be used to write off capital loss or issue of bonus share by the company management.
16. Asset Revaluation
The management can revalue the assets. The surplus on revaluation of assets can be started on liability side of balance sheet. It can be used after realization. The assets may be sold and profit may be realized.
17. Solvency of Company
The solvency of the business is very important than payment of dividend. The management must determine cash needs of the company. If cash is surplus than business requirements then dividend then can be paid is cash. In cash of storage of funds dividend should not be paid in cash.
18. Creditors Protection
It is a principle of divisible profits that dividend must be paid out of revenue profits. The correct calculation is essential for all who depend upon business. The overstatement can disturb one section of investors while understatement can upset another group.