MCom I Semester Corporate Accounting Disposal Profit Issue Bonus Shares Study Material Notes
Table of Contents
MCom I Semester Corporate Accounting Disposal Profit Issue Bonus Shares Study Material Notes: Divisible Profits Voluntary transfer Higher Percentage Declaration dividend out Reserve Interest out of Capital Dividend Separate Bank Account for Dividends Bonus Shares Journal Entries :
CTET Paper Level 2 Language II Model paper in English
Disposal of Profit and Issue of Bonus Shares
Divisible Profits
The term ‘divisible profits’ refers to profits, which are available for dividend to shareholders. From the strict accountancy point of view, profits should be distributed as dividends only when they are left alter meets all expenses, losses, depreciation on fixed assets, fall in the price of current assets, taxation, past losses and transferring a reasonable amount to reserves. Dividend cannot be declared and paid except out of profits.
Legal Position : Section 205 of Companies Act, 1956 lays down the rules for the ascertainment of divisible profits, which are as follows:
(i) Dividend out of current year’s profit : Dividend can be declared out of the profits of current year arrived at after providing for depreciation in accordance with the provisions of Section 205(2).
(ii) Dividend out of previous year or years profits : Dividend can be declared out of the profits of the company for any previous year or years only after providing for such depreciation out of the profits of that year or out of the profits of any other previous year or years.
Disposal Profit Issue
(iii) Dividend out of aggregate profits : Dividend can also be declared out of the aggregate of profits mentioned in (i) and (ii) above after providing for such depreciation. The Central Government may in public interest, allow any company to declare dividend without complying the aforesaid rules.
(iv) Dividend out of subsidy : Dividend can be paid out of moneys provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by that Government.
According to Companies (Amendment) Act, 1988, if a company fails to redeem its irredeemable preference shares in accordance with the provisions of Section 80-A shall not, so long as such failure continues, declare any dividend on its equity shares.
Provision for Depreciation : Section 205(2) of Companies Act provides that depreciation can be calculated by any of the following ways:
(i) to the extent specified in Section 350. As per amendment made in 1988, depreciation shall be calculated on the written down value of asset at the rates specified in Schedule XIV; or
(ii) in respect of each item of depreciable asset, for such an amount as is arrived at by dividing 95% of the original cost thereof to the company by the specified period in respect of such asset; or
(iii) on any other basis approved by the Central Government which has the effect of writing off by way of depreciation 95% of the original cost to the company of each such depreciable asset on the expiry of the specified period; or
(iv) as regards any other depreciable asset for which no rate of depreciation has been laid down by this Act or any rule made thereunder, on such basis as may be approved by the Central Government by any general order published in the Official Gazette or any special order in any particular case.
Disposal Profit Issue
Arrears of Depreciation : If the company has not provided for depreciation for any previous year or years which falls or fall after the commencement of Companies (Amendment) Act, 1960, it shall before declaring dividend for any financial year provide for such depreciation out of the profits of that financial year or out of the profits of any other previous financial year or years.
Provision for current year’s depreciation and set off of arrears of depreciation are necessary for calculating divisible profits. But if dividend is paid out of the profits of any previous financial year or years Which Falls falls or fall before the commencement of Companies (Amendment) Act, 1960 (i.e. 28th December 1960), it shall not be necessary to provide depreciation as aforesaid.
Past Losses : If the company has sustained any loss in any past year or years falling after 28th December 1960 then before declaring dividend, amount of such loss or an amount equal to the amount provided for depreciation for that year or years, whichever is less, must be set off against the current year’s profits of the company or against the profits of any past year or years arrived at in both cases after providing for depreciation in accordance with sub-section (2). S
Transfer of Profits to Reserves : Section 205 (2A) of the Companies Act, inserted by Companies (Amendment) Act, 1974, authorizes the Central Government to force the companies to transfer a part of their profits after tax for the year to reserves not exceeding 10%. By framing the Companies (Transfer of Profits to Reserves) Rules, 1975, the Central Government has prescribed the following percentage of profits to be transferred to reserves :
Disposal Profit Issue
Proposed Dividend Minimum amount to be transferred to reserves
(Percentage of Profits of Current Year)
(a) Exceeding 10% but not more than 12 % of paid up capital 2.5%
(b) Exceeding 127% but not more than 15% of paid up capital 5%
(b) Exceeding 15% but not more than 20% of paid up capital 7.5%
(b) Exceeding 20% of paid up capital 10%
It is to be noted that where the proposed dividend is upto 10%, it is not obligatory on the part of the company to transfer any portion of its profits to reserves. However, the Directors, exercising their discretion, can transfer any portion of the profits to reserves within the ceiling of 10%.
Notes : (i) Here, the term reserves means free reserves.
(ii) Current profits means profits after tax. Write back of Investment Allowance Reserve (or Development Rebate Reserve) or adjustments of past years shall be considered in determining current profits.
(iii) Dividend means equity dividend and also includes the portion of dividend relating to participating preference shares over and above the fixed rate of dividend.
Voluntary Transfer at Higher Percentage
A company may voluntary transfer a higher than 10% of its profits to the reserves for any financial year provided however that:
(i) where a dividend is declared :
(a) a minimum distribution of dividend at a rate equal to the average of the rates for the three immediately preceding years is ensured; or
(b) in a case where bonus shares have been issued in the current financial year or in the three years immediately preceding the financial year, a minimum distribution of dividend equal to the average amount (quantum and not the rate) of dividend declared over the three immediately preceding years is ensured.
However, it shall not be necessary to ensure such minimum distribution, if net profits after tax have reduced by 20% or more than the average net profits after tax of the two immediately preceding financial years.
(ii) Where no dividend is declared the amount proposed to be transferred to its reserves from current profits shall be lower than the average amount of the dividends to the shareholders declared by it over the three immediately preceding financial years.
Disposal Profit Issue
Declaration of Dividend Out of Reserves
Section 205-A (3) of Companies Act provides that a company can declare dividend out of its reserve only according to the rules framed by Central Government in this regard. The Central Government framed these rules known as Companies (Declaration of Dividend out of Reserves) Rules, 1975. Rule these rules provides that in the event of inadequacy or absence of profits in any year, dividend may declared out of the accumulated profits transferred to reserves subject to the following conditions:
(1) The rate of the dividend shall not exceed the average of the rates at which dividend was declared by it m the five years immediately preceding that year or 10% of its paid up capital, whichever is less.
(2) The total amount to be drawn from such reserves shall not exceed an amount equal to one-tenpin the sum of its paid-up capital and free reserves and the amount so drawn shall first be utilized to set of the losses incurred in the financial year and only the balance can be utilised for declaring the dividend.
(3) The balance of reserves after such draw shall not fall below 15% of its paid up share capital
Notes : (1) A company need not satisfy these conditions where dividend is declared out of prom carried forward in profit and loss account without being transferred to reserves.
(11) The reserves include amount transferred from Development Rebate Reserve and exclude all capital reserves including reserves created by revaluation of assets.
Illustration 1. Due to inadequacy of profit during the current year, the Rohit Company Ltd. proposed to declare dividend out of general reserves. From the following particulars you are to ascertain the amount that can be drawn applying the Companies (Declaration of Dividend Out of Reserves) Rules, 1975.
Rs.
(i) 8,750 10% Preference shares of Rs. 100 each fully paid 8,75,000
(ii) 4,00,000 Equity Shares of Rs. 10 each fully paid 40,00,000
(iii) General Reserves 10,2 5,000
(iv) Capital Reserves on revaluation of assets 1,75,000
(v) Share Premium 2,00,000
(vi) Profit and Loss Account – Credit balance 50,000
(vii) Net Profit for the year 2,00,000
(viii) Dividends declared during immediately preceding five years 12.5%, 15%, 17%, 18% and 15%.
Payment of Dividend Out of Capital Profits
Ordinarily capital profits are not used for paying dividend. As per various judicial decisions, they can be utilized for this purpose only when :
(1) such profits are realized in cash,
(2) surplus remains even after the revaluation of all assets and liabilities and
(3) the Articles do not prohibit such distribution.
However, under the Companies Act, premium on issue of shares and debentures, capital redemption reserve account and profit on reissue of forfeited shares are not available for dividend distribution. Further. Contain type of capital profits, such as profit on sale of fixed assets, profit on redemption of decent
Pronto prior to incorporation are also not available for dividend distribution. It is to be noted that if any ha profit is transferred to capital reserve then also it ceases to be available for dividend distortion,
Disposal Profit Issue Bonus
Dividend
The term ‘dividend’ refers to that part of divisible profits of a company, which is distributed among its Shareholders. Dividend is distributed in accordance with the rules as laid down in the Articles of the company. The directors of the company in their meeting recommend dividends on the various classes of shares specifying the rate for each class of shares and after its approval in the annual general meeting of the Shareholders, it is said to be declared by the company. The shareholders have the right to approve or reject the dividend proposals; they can also reduce the rate of dividend as recommended by the Board of Directors but they have no right to increase its rate. The discretion as to whether to declare dividend or not has been left with the Board of Directors. The shareholders themselves can not declare dividend in the general meeting. However, once a dividend has been declared in the general meeting, it becomes a debt of the company and the shareholders become entitled to sue at law against the company for the recovery of the same.
Statutory Provisions : The Companies Act, 1956 makes the following provisions regarding the declaration and payment of dividends –
(1) Dividend can be declared out of divisible profits only or out of money provided by the Central or a State Government
(2) Before declaring dividend for any financial year following after 27th December 1960, it is necessary, unless exempted by the Central Government in public interest, to provide for depreciation of fixed assets in respect of current financial year, arrears of depreciation of past year or years falling after 27th December 1960 and losses in respect of any past year or years falling after 27th December 1960, to the extent not provided for.
(3) In the absence of any specific indication to the contrary, dividend is calculated at the declared rate on the paid-up value of shares. If Articles specifically provide dividend can also be declared on the nominal value or called up value of shares.
(4) No company can pay dividend on calls-in-advance of shares. If there are calls-in-arrear, dividend is usually calculated on the amounts actually paid by the shareholders. However, by suitable provision in its Articles, a company can forbid the payment of dividend on shares on which there are calls-in-arrear.
(5) If any shares have been issued during the current financial year, dividend on such shares is calculated proportionately on the basis of the date of their issue. However, there is no restriction on issue of shares by a company on the term of paying dividend on such shares from a specified date.
(6) All dividends must be paid in cash. But this restriction does not apply on issue of bonus shares.
Disposal Profit Issue
(7) Dividend is payable only to the registered shareholders or on his order to his banker. However, where the company has issued share warrants according to Sec. 114, dividend is to be paid to the bearer of such warrants or to his banker.
(8) Dividend must be paid within 30 days of declaration. If any dividend remains unpaid/unclaimed, then within 7 days of the expiry of the 30th day, the amount remaining unpaid must be deposited in a special account, styled as ‘Unpaid Dividend Account of ………. Company Ltd.’ with any scheduled bank. After such transfer any claims by the shareholders will be paid from such account. If the amount is not transferred to the said account, the company is liable to pay interest at the rate of 12% per annum to the shareholders on the unpaid amount. The Companies (Amendment) Act 1999 provides that any money transferred to unpaid dividend account and which remains unpaid or unclaimed for a period of seven years from the date of such transfer. shall be transferred to the Investor Education and Protection Fund to be established by Central Government. No payment out of this Fund shall be made in respect of any such claims
(9) Holders of preference shares are entitled to receive a dividend at a fixed rate before any dividend equity shareholders. In the case of cumulative preference shares, the holders of such shares are entitled to receive all arrears of dividend before any dividend is paid to equity shareholders In respect of preference shares issued before Ist April 1960, the dividend payable is to be increased by 30% if the dividend payable was stipulated to be tax-free and by 11% in other case. This is required by the Preference Shares (Regulation of Dividend) Act, 1960.
(10) Clause 86 of Table A empowers the Board of Directors to pay interim dividend from time to time as it appears to be justified by the profits of the company.
(11) After declaration of the dividend the shareholders must be informed.
Disposal Profit Issue
Interest out of Capital
Dividends can not be paid out of capital. However, a company may pay interest out of capital in the following two exceptional cases :
(1) Under Section 92(1) where interest is paid on calls-in-advance accepted by the company.
(2) Under Section 208 where shares are issued for the purpose of defraying the expenses of the construction of any works or building or providing any plant which can not be made profitable for a lengthy period subject to the following conditions:
(a) The company is constructing a fixed asset and there is no possibility of dividend being paid to shareholders for a long period.
(b) The payment of interest is authorised by Articles or by a special resolution.
(c) Prior sanction of the Central Government is obtained.
(d) Interest is paid only for such period as may be determined by the Central Government and shall not be longer than the end of the half-year next after the half year during which the construction was completed or plant provided.
(e) The rate of interest does not exceed 4% per annum or such other rate as is fixed by the Central Government.
Interim Dividend : This is a dividend paid by a company for the current year before the accounts for that period have been closed. It can be paid if authorised by the Articles. Clause 86 of Table A empowers the Board of Directors to pay interim dividend from time to time as it appears to be justified by the profits of the company. New Sub-section (1A) inserted in Section 205 by Companies (Amendment) Act 2000 provides that the Board of Directors may declare interim dividend and the amount of dividend shall be deposited in a separate bank account within five days from the date of declaration of such dividend. Interim dividend must be distributed within 30 days of its declaration and unpaid amount must be transferred to the Unpaid Dividend Bank Account within 7 days from the expiry of 30 days from the date of declaration.
Since the profits of the company can not be known exactly till the accounts are closed, the directors have to be extremely careful. If an interim dividend is paid and subsequently it is found that the company’s profits are inadequate to cover this amount, the directors will then have to make good the amount. As such, the directors should get the accounts prepared upto a certain date and declare interim dividend on a very conservative basis after providing for full year’s depreciation, accumulated past losses, arrears of depreciation and statutory transfer to reserve. It is to be noted that the directors have the right to cancel the declared interim dividend before it is actually paid off, even when the cash for interim dividend has been deposited in a separate bank account.
Final Dividend : After the accounting year is closed, dividend proposed by the directors out of divisible profits of the company and which the shareholders approve in the annual general meeting is called final dividend. When a final dividend is declared then interim dividend, if any, is not adjusted unless the resolution mentions it specifically.
Interim dividend and final dividend both are shown on the debit side of Profit and Loss Appropriation Account After the dividend is declared a list of dividend is prepared with the help of register of met find out the amount of dividend payable to each shareholder. This list is prepared separately for ca of shares, a specimen of which is given below:
| Page No. of the Register of Members | Name of the Shareholders | Address | NO of Shares | Amount Paid up on Shares | SN of Dividend Warrant | Amount of the Dividend | Income Tax | Net Dividend |
Dividend warrants are prepared with the help of this list and these are sent to the shareholders who encase them from the company’s bank. Difference between Interim Dividend and Final Dividend
1 Interim dividend is declared during the year in anticipation of profits before the final accounts for that year are prepared while final dividend is declared after the final accounts have been prepared.
2. Interim dividend is based on estimates and opinions while the final dividend is based on facts contained in balance sheet and profit and loss account
3. The Board of Directors have the right to declare interim dividend but as regards final dividend, the Board simply proposes and it is assumed to be declared only when the shareholders confirm the Board’s proposal in the annual general meeting.
4. Interim dividend can be cancelled before it is paid off but a final dividend once declared by the company in the annual general meeting is a debt and enforceable.
Separate Bank Account for Dividends
In view of the requirements of Section 205A, it is better to open a separate bank account for the payment of dividend. So, when a dividend, whether interim or final, is declared by a company, an amount equal to the net amount payable (i.e., after deduction of tax) is transferred from general bank account to a separate account titled as Dividend Bank Account within 5 days from the date of declaration. All dividend warrants will be paid out of and debited to such an account. The balance of this account will be equal to the dividend, which have not been claimed and paid off. After lapse of 30 days from the date of dividend declaration, this account is closed by transferring it to Unpaid Dividend Bank Account within 7 days of the expiry of the said period of 30 days.
The Companies (Amendment) Act 1999 provides that any money transferred to Unpaid Dividend Bank Account of a company remains unpaid or unclaimed for a period of 7 years from the date of such transfer, shall be transferred to the Investor Education and Protection Fund to be established by the Central Government and no claims could be made against the Fund for the recovery of unpaid amount. This fund shall be utilized for the promotion of investor awareness and protection of interests of investors.
Disposal Profit Issue
Corporate Dividend Tax
The Finance Act, 1997 has introduced, with effect from 1st June 1997, a new scheme for taxation on dividend at the rate of 10% on the amount so distributed. The rate of corporate dividend tax is decided by Finance Bill each year’. The main features of the scheme are as follows:
1 This tax is designated as ‘corporate dividend tax’.
2. Only a domestic company is liable to pay this tax.
3. This tax is paid in addition to the income tax chargeable in respect of total income.
4. This tax is chargeable on companies declaring, distributing or paying dividend, whether interim or otherwise.
5. The dividends may be out of the current profits or accumulated profits. The present rate for financial year 2005-06 is 12.5% with an additional surcharge of 10% plus 2% for education cuss, Te, the effective rate is 14.025%.
6. This tax shall be parable even if no income tax is payable by the company on its total income.
7. This tax is payable to the credit of Central Government within 14 days from the date of (a)declaration, (b) distribution, or (c) payment of any dividend, whichever is earliest.
8. The tax so paid by the company shall be treated as the final payment of tax on dividends and no further credit there for shall be claimed by the company or any person in respect of the tax so paid.
Accounting Disclosure : Since the liability in respect of corporate dividend tax arises only if the profits are distributed as dividends (and not on the earnings of the taxable profits) and distribution of profits is disclosed below the line’ (i.e. in Profit and Loss Appropriation Account). it is quite appropriate that the liability in respect of corporate dividend tax should be disclosed below the line’ as a separate item. Furthermore, corporate dividend tax liability should be recognized in the accounts of the same financial year in which the dividend concerned is recognized. It should be disclosed in the P. & L. Appropriation Account as under:
Disposal Profit Issue
Bonus Shares
Meaning of Bonus : A distribution made by a company to its shareholders other than the dividend is termed as bonus. It is an extra dividend for whose continuance there is no guarantee. It is declared when the company is earning profits much greater than normal. It is of two types: (1) cash bonus and (2) capital bonus.
Cash Bonus : A distribution in cash made by a company among its shareholders other than the regular dividend is known as the cash bonus. This is given when the profits of the company are very high and it has ample cash for distribution. But if the company is short of liquid funds or it needs funds for its future expansion, cash bonus may check the progress of the company. Hence, cash bonus is justified only when there is sudden heavy rise in the profits of the company in a particular year but the company does not want to increase the rate of regular dividend or issue of bonus shares is not possible due to the limits of authorised capital of the company.
Capital Bonus : Capital bonus (or stock dividend) implies distribution of its shares by a company as dividend to its shareholders. In other words, issue of shares by a company to its existing shareholders without taking any thing in consideration is known as capital bonus or stock dividend and the shares so issued are known as bonus shares. Such issue may be at par or at premium. The effects of issue of bonus shares are: (1) a reduction in the amount of accumulated profits and reserves and (2) a corresponding increase in the paid-up share capital of the company. As accumulated profits and reserves of the company are converted into its share capital, this is also known as ‘capitalisation of profits and reserves’. It may be done in two ways:
(i) by making partly paid shares as fully paid without requiring the shareholders to pay the uncalled amount of their shares.
(ii) by issuing fully paid shares to existing shareholders without requiring them to pay anything in consideration.
Whether partly paid shares are made fully paid or fresh fully paid shares are issued to the shareholders, it does not have any adverse effect on the company’s cash position. Hence, when a company has huge amount of accumulated profits and reserves but is short of cash resources for dividend payment or if it wants to build up cash resources for its development and expansion then it may satisfy its shareholders by issuing bonus shares.
Sources of Bonus Issue of Shares : Bonus shares can be issued out of the following:
1 Balance in the Profit and Loss Account.
2. General Reserves or other reserves created out of profits, e.g., Development Rebate Reserve. Investment Allowance Reserve.
3. Balance in the Sinking Fund Account after debentures have been redeemed.
4. Realized capital profits and reserves.
5. Balance of Securities Premium Account.
6. Capital Redemption Reserve Account.
It is to be noted that of the above 5 and 6 can be used only for issuing fully paid bonus shares.
Disposal Profit Issue
SEBI Guidelines for Issue of Bonus Shares
In tune with current liberalization and reforms measures, the Securities and Exchange Board of India
vide its press release dated 13-4-1994 modified the guidelines for bonus issue. The text of modified guidelines are given below:
(i) Applicability : These guidelines are applicable to existing listed companies who shall forward certificate duly signed by the issuer and duly countersigned by its statutory auditor or by a company secretary in practice to the effect that the terms and conditions for issue of bonus shares as laid down in these guidelines have been complied with.
(ii) Rights of FCDs / PCDs holders : Issue of bonus shares after any public/right issue is subject to the condition that no bonus issue shall be made which will dilute the value or rights of the holders of debentures, convertible fully or partly. In other words, no company shall, pending conversion of FCDs/PCDs, issue any shares by way of bonus unless similar benefit is extended to the holders of such FCDs/PCDs, through reservation of shares in proportion to such convertible part of FCDs or PCDs. The shares so reserved may be issued at the time of conversion(s) of such debentures on the same terms on which the bonus issues were made.
(iii) Out of Free Reserves : The bonus issue is made out of free reserves built out of the genuine profits or securities premium collected in cash only.
(iv) Revaluation Reserves : Reserves created by revaluation of fixed assets are not capitalized.
(V) Bonus in Lieu of Dividend : The declaration of bonus issue, in lieu of dividend is not made.
(vi) Fully Paid Shares : The bonus issue is not made unless the partly paid shares, if any existing, are made fully paid-up.
(vii) No Default in respect of fixed deposits/debentures and statutory dues : The company :
(1) has not defaulted in payment of interest or principal in respect of fixed deposits and interest on existing debentures or principal on redemption thereof, and (2) has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity, bonus etc. (viii) Implementation : A company, which announces its bonus issue after the approval of the Board of Directors must implement the proposal within a period of six months from the date of such approval and shall not have the option of changing the decision.
(ix) Provision in Articles : There should be a provision in the Articles of Association of the company for capitalisation of reserves etc. and if not, the company shall pass a resolution at its General Body Meeting making provisions in the Articles of Association for capitalisation.
(x) Authorised Capital : Consequent to the issue of bonus shares if the subscribed and paid-up capital exceed the authorised share capital, a resolution shall be passed by the company at its General Body Meeting for increasing the authorised capital.
Disposal Profit Issue Bonus
Accounting for Bonus Issue of Shares
(1) On sanction and declaration of bonus :
Profit & Loss Appropriation Account Dr.
Securities Premium Account
Respective Reserve Account
To Bonus to Shareholders Account
(2) On payment of bonus in cash :
Bonus to Shareholders Account Dr.
To Bank Account
(3) On payment of bonus by issue of shares :
Bonus to Shareholders Account Dr.
To Share Capital Account
Note: If bonus shares are issued at premium, securities premium account will be credited with the amount of premium.
(4) On payment of bonus by issue of debentures :
Bonus to Shareholders Account Dr.
To Debentures Account
(5) When bonus is declared for making partly paid shares fully paid
(a) On making final call :
Share Final Call Account Dr.
To Share Capital Account
(b) On applying the bonus towards calls on shares :
Bonus to Shareholders Account Dr.
To Share Final Call Account
Illustration 8. A limited company has share capital, which consists of 10,000 equity shares of Rs. 10 each, Rs. 7 per share called and paid. The company has also a reserve fund of Rs. 1,50,000. The company passed a resolution declaring a bonus of Rs. 1,05,000 for the shareholders. The bonus is to be utilised for making partly paid shares as fully paid and the balance to be used for the allotment of fully paid shares at 25% premium
Pass necessary journal entries to give effect to the above resolution of the company,
Disposal Profit Issue
