Before declaring dividend a number of factors are to be considered.
(1) Capital Profits. Capital profits cannot be distributed as dividend unless (a) they are actually earned, (b) all other assets have been revalued, (b) depreciation in the value of other assets was set off against the appreciated value of the asset, (d) the Company’s Articles permit such distribution.
(2) Transfer to Reserve. Any profits appropriated to reserves or carried forward to the next year, by the Directors, are not available for dividend. First, provision for reserve must be made according to the Articles of Association. Second, reserve may have to be created to meet some contractual requirements, e.g. for the redemption of debentures or redeemable preference shares, Third, in case of certain companies, e.g. banking and electricity companies, the reserve is legally required to be created. Finally, . the directors should transfer a portion of the profits to the general reserve to strengthen the financial position of the company.
(3) Dividend Equalisation Reserve. Since profits of the company fluctuate from year to year, a part of the profits should be transferred to the Dividend Equalisation Reserve. This will help the company to utilise this reserve in maintaining uniformity in the declaration of dividends. The fluctuation in the rate of dividend tends to affect the value of share in the market.
(4) Cash Requirements. Before declaring dividend, the cash position of the company is to be seriously considered.
(5) Preference Shares. Preference shareholders must be paid dividend before declaring dividends to equity shareholders.
(6) Past Policy. A consistent policy should be followed in declaring dividend.
(7) Development Rebate Reserve. A reserve is to be created in compliance with one of the conditions for claiming development rebate under the Income Tax Act, 1961.
Profits Prior to Incorporation
(a) What is meant by “Profits prior to Incorporation”? (b) Will such profits be available for dividend ? (c) What are the different purposes for which such profits can be utilised ?
(a) Frequently, a company takes over a running business as and from a date prior to the incorporation of the company itself. In such an event any profits earned prior to the date of incorporation are considered “profits prior to incorporation”.
(b) A Company cannot be said to have earned profits before it comes into existence. Hence all profits earned by the company prior to incorporation cannot be regarded as profits available for dividend.
(c) A company can utilise “profits prior to incorporation” for any of the following purposes: The first charge on such profits will be the amount of interest on the purchase consideration payable to the vendors. Usually, the vendors are entitled to interest on the purchase consideration from the date when the business was taken over to the date when the purchase consideration was discharged. Such interest can be charged against the profits earned during that period. The remaining balance of profit earned prior to incorporation (if any) should be written off Goodwill. If there is no Goodwill, it would be utilised in writing down some other fixed assets, or may be carried forward as Capital Reserve not available for dividend.