Unit 1 Final Account
Final Accounts and Financial reporting
Meaning of dividend and its type:
Shareholders expect some return for the money invested by them in the company. They get the return on their investment in the form of dividends given to them from time to time. Thus, dividends are the profits of the company distributed amongst the shareholders. The company may declare dividends in general meeting, but no dividend shall exceed the amount recommended by the Board of Directors. Thus, shareholders in annual general meeting can only reduce the amount of dividends but cannot increase the amount of dividends recommended by the Board of Directors. The directors may no recommend dividend even if there are profits if they think that distribution of dividend will impair the financial position of the company.
Dividends are usually paid on the paid up value shares in the absence of any indication to the contrary in the Articles of Association. For example, if a company has share capital of 1,00,000 equity shares of Rs. 10 each, Rs. 7 per share called up, and paid up and if the rate of dividend is 15%, total dividend paid will be 15% of Rs. 7,00,000 paid up capital (i.e. 1,00,000 shares @ 7 each) i.e. Rs. 1,05,000.
Sources of Declaring Dividend
As per Section 123 of the Companies Act, 2013 dividend may be declared out of the following three sources:
1) Out of Current Profits: Dividend may be declared out of the profits of the company for the current year after providing depreciation. The company must transfer the prescribed percentage of its profits to general reserve before declaring dividends. This percentage depends on the percentage of dividend declared.
2) Out of Past Reserves: Dividend may be declared out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with the provisions of Schedule II of the Companies Act, 2013 and remaining undistributed. Section 123 of the Act, requires that dividend can be declared out of the reserves only in accordance with the rules framed by the Central Government in this behalf.
3) Out of Money provided by the Government: A company can also declare dividend out of the moneys provided by the Central Government for payment of such dividend in pursuance of guarantee given by the Government.
Dividends may be of the following two types:
1) Interim Dividend.
2) Final Dividend.
Interim Dividend: This dividend is declared between two annual general meetings. Section 123 of the Companies Act, 2013 provides that the Board of Directors of a company may declare interim dividend during any financial year out of the surplus in the profit and loss account and out of profits of the financial year which interim dividend is sought to be declared. It further provides that in case the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall no be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years. The Board may from time to time pay to the shareholders such interim dividends as appear to it to be justified keeping in view the profits of the company.
Distinction between Interim Dividend and Final Dividend
1) Interim dividend is the dividend which is paid in anticipation of profits. It is dividend paid by the directors any time between the two annual general meetings of the company, that is, on the basis of less than a full year’s results. Final dividend is recommended by the directors and declared by the shareholders in the Annual General meeting.
2) The payment of interim dividends depends much more upon estimates and opinions than the declaration of a final dividend which is made upon the information contained in the Final Balance Sheets.
3) Once a final dividend is declared, it is a debt payable to the shareholders and cannot be revoked or reduced by any subsequent action of the company. But declaration of interim dividend does not create a debt against the company and can be rescinded or reduced at any time before payment.
4) For declaration and payment of interim dividend, the directors need to satisfy that there are adequate distributable profits and payment of interim dividend would not result in payment out of capital.
Corporate Dividend Tax: As per the Finance Act, 1997 dividends paid or declared were subject to corporate dividend tax @ 10% with effect from 1st June, 1997. Such corporate dividend tax is deducted from Surplus sub-head in the Balance Sheet and it is also shown under the heading current liabilities as a provision till it is paid. But as per recent Finance Act, the rate of this tax is 15% plus 10% surcharge and cess of 2%. Total percentage of corporate dividend tax with surcharge and education cess comes to 17% approximately.
Divisible Profits and Rules regarding Dividends and Transfer to reserves
The term “Divisible Profit” is a very complicated term because all profits are not divisible profits. Only those profits are divisible profits which are legally available for dividend to shareholders. Dividends cannot be declared except out of profits, i.e. excess of income over expenditure; ordinarily capital profits are not available for distribution amongst shareholders because such profits are not trading profits. Thus, profits arising from revaluation or sale of fixed assets or redemption of fixed liabilities should not be available for distribution as dividend amongst shareholders. The principles of determination of the divisible profit are given below:
1) According to Section 123 of the Companies Act, 2013 no dividends can be declared unless:
⮚ Depreciation has been provided for in respect of the current financial years for which dividend is to be declared;
⮚ Arrears of depreciation in respect of previous years have been deducted from the profits; and
⮚ Losses incurred by the company in the previous years.
Provided that nothing in this sub-section shall be deemed to prohibit the voluntary transfer by a company of a higher percentage of its profits to the reserves in accordance with such rules as may be made by the Central Government in this behalf.
3) No dividend shall be payable except in cash;
4) There is no prohibition on the company for the capitalization of profits or reserves of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount for the time unpaid on any shares held by the members of the company.
5) Any dividend payable in cash may be paid by cheque or warrant sent through the post directed to the registered address of the shareholder entitled to the payment of the dividend or in the case of joint shareholder to the registered address of that one of the joint shareholder which is first named on the register of members or to such person and to such address as the shareholder or the joint shareholder may in writing direct.”
Transfer to Reserves: Section 123 of the Companies Act, 2013 provides that
No dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Schedule II, except after the transfer to the reserves of the company a certain percentage of its profits for that year as specified:
i. Where the dividend proposed exceeds 10 percent but not 12.5 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 2.5 percent of the current profits;
ii. Where the dividend proposed exceeds 12.5 percent but does not exceeds 15 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 5 percent of the current profits;
iii. Where the dividend proposed exceeds 15 percent, but does not exceed 20 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 7.5 percent of the current profits; and
iv. Where the dividend exceeds 20 percent of the paid-up capital, the amount to the transferred to reserves shall not be less than 10 percent of the current profits.
Books of Accounts to be maintained by a Company
The company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed. The books of account and other books and papers maintained by the company within India shall be open for inspection at the registered office of the company. The books of account of every company relating to a period of not less than eight financial years immediately preceding a financial year, or where the company had been in existence for a period less than eight years, in respect of all the preceding years together with the vouchers relevant to any entry in such books of account shall be kept in good order.
Section 129 of the Companies Act, 2013 requires that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards under Section 133 and shall be in the form or forms as may be provided for different class or classes of companies in Schedule III.
Where a company has one or more subsidiaries, it shall in addition to its financial statements, prepare a consolidated financial statements of the company and of all the subsidiaries in the same form and manner as that of its own which shall also be laid before the annual general meeting of the company along with the laying of its financial statements.
Meaning of Financial Reporting, its components and objectives
Basically, financial reporting is the process of preparing, presenting and circulating the financial information in various forms to the users which helps in making vigilant planning and decision making by users. The core objective of financial reporting is to present financial information of the business entity which will help in decision making about the resources provided to the reporting entity and in assessing whether the management and the governing board of that entity have made efficient and effective use of the resources provided. The components of financial reporting are:
a) The financial statements – Balance Sheet, Profit & loss account, Cash flow statement & Statement of changes in stock holder’s equity
b) The notes to financial statements
c) Quarterly & Annual reports (in case of listed companies)
d) Prospectus (In case of companies going for IPOs)
e) Management Discussion & Analysis (In case of public companies)
Objectives of Financial Reporting
The following points sum up the objectives & purposes of financial reporting:
a) Providing information to management of an organization which is used for the purpose of planning, analysis, benchmarking and decision making.
b) Providing information to investors, promoters, debt provider and creditors which is used to enable them to male rational and prudent decisions regarding investment, credit etc.
c) Providing information to shareholders & public at large in case of listed companies about various aspects of an organization.
d) Providing information about the economic resources of an organization, claims to those resources (liabilities & owner’s equity) and how these resources and claims have undergone change over a period of time.
e) Providing information as to how an organization is procuring & using various resources.
f) Providing information to various stakeholders regarding performance of management of an organization as to how diligently & ethically they are discharging their fiduciary duties & responsibilities.
g) Providing information to the statutory auditors which in turn facilitates audit.
h) Enhancing social welfare by looking into the interest of employees, trade union & Government.
Qualitative Characteristics of Financial Reports
The Qualitative characteristics that make financial information useful:
a) Relevance: Information is relevant if it would potentially affect or make a difference in users’ decisions. A related concept is that of materiality i.e. information is considered to be material if omission or misstatement of the information could influence users’ decisions.
b) Faithful Representation: This means that the information is ideally complete, neutral, and free from error. The financial information presented reflects the underlying economic reality.
c) Comparability: This means that the information is presented in a consistent manner over time and across entities which enables users to make comparisons easily.
d) Verifiability: This means that different knowledgeable and independent observers would agree that the information presented faithfully represents the economic phenomena it claims to represent.
e) Timeliness: Timely information is available to decision makers prior to their making a decision.
f) Understandability: This refers to clear and concise presentation of information. The information should be understandable by users who have a reasonable knowledge of business and economic activities and who are willing to study the information with diligence.
International Financial Reporting Standards (IFRS)
IASB issued only thirteen (13) IFRS which are as follows:
IFRS 1 - First-time adoption of International Financial Reporting Standards
IFRS 2 - Share-based payment
IFRS 3 - Business combinations
IFRS 4 - Insurance contracts
IFRS 5 - Non-current assets held for sale and discontinued operations
IFRS 6 - Exploration for and evaluation of mineral resources
IFRS 7 - Financial instruments: disclosures
IFRS 8 - Operating segments
IFRS 9 - Financial instruments
IFRS 10 - Consolidated financial statements
IFRS 11- Joint arrangements
IFRS 12- Disclosure of interests in other entities
IFRS 13- Fair Value measurement
Need and Importance of IFRS
The goal of IFRS is to provide a global framework for how public companies prepare and disclose their financial statements. IFRS provides general guidance for the preparation of financial statements, rather than setting rules for industry-specific reporting. Having an international standard is especially important for large companies that have subsidiaries in different countries. Adopting a single set of world-wide standards will simplify accounting procedures by allowing a company to use one reporting language throughout. A single standard will also provide investors and auditors with a comprehensive view of finances.
Merits of IFRS
1. IFRS brings improvement in comparability of financial information and financial performance with global peers and industry standards. This will result in more transparent financial reporting of a company’s activities which will benefit investors, customers and other key stakeholders in India and overseas.
2. The adoption of IFRS is expected to result in better quality of financial reporting due to consistent application of accounting principles and improvement in reliability of financial statements.
3. IFRS provide better access to the capital raised from global capital markets since IFRS are now accepted as a financial reporting framework for companies seeking to raise funds from most capital markets across the globe.
4. IFRS minimize the obstacles faced by Multi-national Corporations by reducing the risk associated with dual filings of accounts.
5. The impact of globalization causes spectacular changes in the development of Multi-national Corporations in India. This has created the need for uniform accounting practices which are more accurate, transparent and which satisfy the needs of the users.
6. Uniform accounting standards (IFRS) enable investors to understand better the investment opportunities as against multiple sets of national accounting standard.
7. With the help of IFRS, investors can increase the ability to secure cross border listing.
Limitations of IFRS
1. The perceived benefits from IFRS’ adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. Any decline in market confidence in India and overseas coupled with tougher economic conditions may present significant challenges to Indian companies.
2. IFRS requires application of fair value principles in certain situations and this would result in significant differences in financial information currently presented, especially in relation to financial instruments and business combinations.
3. This situation is worsened by the lack of availability of professionals with adequate valuation skills, to assist Indian corporate in arriving at reliable fair value estimates.
4. Although IFRS are principles-based standards, they offer certain accounting policy choices to preparers of financial statements.
5. IFRS are formulated by the International Accounting Standards Board (IASB) which is an international standard body. However, the responsibility for enforcement and providing guidance on implementation vests with local government and accounting and regulatory bodies, such as the ICAI in India. Consequently, there may be differences in interpretation or practical application of IFRS provisions, which could further reduce consistency in financial reporting and comparability with global peers.
More notes will be updated very soon......