Preparation of Financial Statements

  • By TeamKoncept
  • 7 July, 2023
Preparation of Financial Statements

Preparation of Financial Statements

Table of Content

1. MEANING OF COMPANY

As per Section 2(20) of the Companies Act, 2013, “Company” means a company incorporated under the Companies Act, 2013 or under any previous company law (e.g., the Companies Act, 1956). Different types of companies have been defined (under various sub-sections of the Companies Act, 2013) as follows:

2(21) “company limited by guarantee” means a company having the liability of its members limited by the memorandum to such amount as the members may respectively undertake to contribute to the assets of the company in the event of its being wound up;

2(22) “Company limited by shares” means a company having the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them;
 
2(42) “Foreign company” means any company or body corporate incorporated outside India which –
  1. has a place of business in India whether by itself or through an agent physically or through electronic mode; and
  2. conducts any business activity in India in any other manner.
2(45) “Government company” means any company in which not less than 51% of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company;

2(62) “One Person Company” means a company which has only one person as a member;

2(68) “Private company” means a company having a minimum paid-up share capital as may be prescribed, and which by its articles,—
  1. restricts the right to transfer its shares;
  2. except in case of One Person Company, limits the number of its members to two hundred:

    Provided that where two or more persons hold one or more shares in a company jointly, they should, for the purposes of this sub-clause, be treated as a single member:

    Provided further that—
    (A) persons who are in the employment of the company; and
    (B) persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased, should not be included in the number of members; and

  3. prohibits any invitation to the public to subscribe for any securities of the company;
2(71) “Public Company” means a company which—
  1. is not a private company;
  2. has a minimum paid-up share capital as may be prescribed:
Provided that a company which is a subsidiary of a company, not being a private company, should be deemed to be public company for the purposes of this Act even where such subsidiary company continues to be a private company in its articles;

2(85) “Small company” means a company, other than a public company, -
  1. paid-up share capital of which does not exceed ` 50 lakhs or such higher amount as may be prescribed which should not be more than ` 5 crores; or
  2. turnover of which as per its last profit and loss account does not exceed ` 2 crores or such higher amount as may be prescribed which should not be more than ` 20 crores:
Provided that nothing in this clause should apply to:
  1. a holding company or a subsidiary company
  2. a company registered under section 8
  3. a company or body corporate governed by any special Act
2(92) “Unlimited company” means a company not having any limit on the liability of its members;

2(46) “Holding company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies;

2(87) “Subsidiary company”, or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company-
  1. controls the composition of the Board of Directors; or
  2. exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies:
    Provided that such class or classes of holding companies as may be prescribed should not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation – For the purposes of this clause, -
  1. a company should be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
  2. the composition of a company’s Board of Directors should be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;
  3. the expression “company” includes any body corporate;
  4. “layer” in relation to a holding company means its subsidiary or subsidiaries;


2. MAINTENANCE OF BOOKS OF ACCOUNT

As per Section 128 of the Companies Act, 2013, Every company should prepare and keep at its registered office books of account and other relevant books and papers and financial statement for every financial year which give a true and fair view of the state of the affairs of the company, including that of its branch office or offices, if any, and explain the transactions effected both at the registered office and its branches and such books should be kept on accrual basis and according to the double entry system of accounting:

Provided further that the company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed.
 
As per Section 128 of the Companies Act, 2013 every company should prepare and keep at its registered office books of account and other relevant books and financial statements accrual basis and accourding to double entry system of accounting for every financial year giving a true and fair view of the state of the affairs.
 
Maintenance at Place other than Registered Office

It is a duty of the company to inform the Registrar of Companies within seven days of the decision in case the Board of Directors decides to maintain books at the place other than the registered office.

In Case of Branch Office

Where a company has a branch office in India or outside India, it should be deemed to have complied with the provisions of the Act, if proper books of account relating to the transactions effected at the branch office are kept at that office and proper summarised returns periodically are sent by the branch office to the company at its registered office or such other place as the Board of Directors has decided.

Section 128 (3) further lays down that the books of account and other books and papers maintained by the company within India should be open for inspection at the registered office of the company or at such other place in India by any director during business hours, and in the case of financial information, if any, maintained outside the country, copies of such financial information should be maintained and produced for inspection by any director subject to such conditions as may be prescribed. Section 128(5) further states that the books of account of every company relating to a period of not less than 8 financial years immediately preceding a financial year, or where the company had been in existence for a period less than 8 years, in respect of all the preceding years together with the vouchers relevant to any entry in such books of account should be kept in good order.
 

3. STATUTORY BOOKS

The following statutory books are required to be maintained by a company under different sections of the Companies Act, 2013:
  • Register of Investments of the company held in its own name (Section 187)
  • Register of Charges (Section 85)
  • Register of Members (Sections 88)
  • Register of Debenture-holders and other Security holders (Section 88)
  • Minute Books (Section 118)
  • Register of Contracts, or arrangements in which directors are interested (Section 189)
  • Register of directors and key managerial personnel and their shareholding (Section 170)
  • Register of Loans and Investments by Company (Section 186)

    In addition, a company usually maintains a number of statistical books to keep a record of its transactions which have resulted either in the payment of money to it or constitute the basis on which certain payments have been made by it.

  • Registers and documents relating to the issue of shares are:

    (i) Share Application and Allotment Book
    (ii) Share Call Book
    (iii) Certificate Book
    (iv) Register of Members
    (v) Share Transfer Book
    (vi) Dividend Register.
 

4. ANNUAL RETURN

In accordance with Section 92 of the Companies Act, 2013, every company should prepare an annual return in the form prescribed by the Companies Act, 2013 signed by a director and the company secretary, or where there is no company secretary, by a company secretary in practice:

Provided that in relation to One Person Company and small company, the annual return should be signed by the company secretary, or where there is no company secretary, by the director of the company.

The annual return should be filed with the Registrar within 60 days from the day on which each of the annual general meeting (AGM) is held or where no AGM is held in any year, within 60 days from the date on which AGM should have been held along with a statement showing the reasons why AGM was not held.


5. FINAL ACCOUNTS

Under Section 129 of the Companies Act, 2013, at the annual general meeting of a company, the Board of Directors of the company should lay financial statements before the company:

Financial Statements as per Section 2(40) of the Companies Act, 2013, inter-alia include -
  1. a balance sheet as at the end of the financial year;
  2. a profit and loss account, or in the case of a company carrying on any activity not for profit, an income and expenditure account for the financial year;
  3. cash flow statement for the financial year;
  4. a statement of changes in equity, if applicable; and
  5. any explanatory note annexed to, or forming part of, any document referred to in (i) to (iv) above:
Provided that the financial statement, with respect to One Person Company, small company and dormant company, may not include the cash flow statement.

 
As per the Amendment, under Chapter I, clause (40) of section 2, an exemption has been provided vide Notification dated 13th June, 2017 under Section 462 of the Companies Act 2013 to a startup private company besides one person company, small company and dormant company. As per the amendment, a startup private company is not required to include the cash flow statement in the financial statements.

Thus the financial statements, with respect to one person company, small company, dormant company and private company (if such a private company is a start-up), may not include the cash flow statement.

Requisites of Financial Statements

It should give a true and fair view of the state of affairs of the company as at the end of the financial year.

Provisions Applicable

(1) Specific Act is Applicable
For instance, any
  1. insurance company
  2. banking company or
  3. any company engaged in generation or supply of electricity? or
  4. any other class of company for which a Form of balance sheet or Profit and loss account has been prescribed under the Act governing such class of company
(2) In case of all other companies
Balance Sheet as per Form set out in Part I of Schedule III and Statement of Profit and Loss as per Part II of Schedule III
Points to be kept in mind while preparing final accounts:
  • Requirements of Schedule III to the Companies Act;
  • Other statutory requirements;
  • Accounting Standards notified by Ministry of Corporate Affairs (MCA) (AS 1 to AS 291);
  • Statements and Guidance Notes issued by the Institute of Chartered Accountants of India (ICAI); which are necessary for understanding the accounting treatment/ valuation/ disclosure suggested by the ICAI.
Compliance with Accounting Standards

As per section 133 of the Companies Act, it is mandatory to comply with accounting standards notified by the Central Government from time to time.

Schedule III of the Companies Act, 2013

As per section 129 of the Companies Act, 2013, Financial statements should give a true and fair view of the state of affairs of the company or companies and comply with the accounting standards notified under section133 and should be in the form or forms as may be provided for different class or classes of companies in Schedule III under the Act.



6. MANAGERIAL REMUNERATION

Managerial remuneration is calculated as a percentage of profit. Managerial remuneration payable by a company is governed by various sections of the Companies Act, 2013 and also Schedule V under the Companies Act, 2013.

The scope of the relevant sections is as below:

Section 197 prescribes the overall maximum managerial remuneration payable and also managerial remuneration in case of absence or inadequacy of profits.
 
As per Section 197 of the Companies Act, 2013, total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year should not exceed 11% of the net profits of that company for that financial year computed in the manner laid down in section 198 except that the remuneration of the directors should not be deducted from the gross profits. The company in general meeting may, with the approval of the Central Government, authorise the payment of remuneration exceeding 11% of the net profits of the company, subject to the provisions of Schedule V.

Provided further that, except with the approval of the company in general meeting,—
  1. the remuneration payable to any one managing director; or whole-time director or manager should not exceed 5% of the net profits of the company and if there are more than one such director, remuneration should not exceed 10% of the net profits to all such directors and manager taken together;
  2. the remuneration payable to directors who are neither managing directors nor whole-time directors should not exceed,—
    (A) 1% of the net profits of the company, if there is a managing or whole- time director or manager;
    (B) 3% of the net profits in any other case.
Section 198 lays down how the net profit of the company will be ascertained for the purpose of calculating managerial remuneration.

Schedule V consists of four parts. Part I lays down conditions to be fulfilled for the appointment of a managing or whole-time director or a manager without the approval of the Central Government. Part II deals with remuneration payable to managerial person by companies having profits and also by companies having no profits or inadequate profits. Part III specifies the provisions applicable to parts 1 and 2 of this schedule and Part IV deals with Central Government’s power to relax any requirements in this Schedule.

The relevant details given under Part II of Schedule V are as follows:

Section I - Remuneration payable by companies having profits:

Subject to the provisions of section 197, a company having profits in a financial year may pay remuneration to a managerial person or persons not exceeding the limits specified in such section.
 
Section II - Remuneration payable by companies having no profit or inadequate profit:

Where in any financial year during the currency of tenure of a managerial person, a company has no profits or its profits are inadequate, it may, pay remuneration to the managerial person not exceeding the higher of the limits under (A) and (B) given below:-
(A)
(1) (2)
Where the effetcive capital is Limit of yearly remuneration payable should not exceed (Rupees)
Negative or less than 5 crores 60 lakhs
5 crores and above but less than 100 crores 84 lakhs
100 crores and above but less than 250 crores 120 lakhs
250 crores and above 120 lakhs plus 0.01% of the effective capiatl in excess of 250 crores

Provided that the remuneration in excess of the above limits may be paid if the resolution passed by the shareholders is a special resolution.

Explanation - It is hereby clarified that for a period less than one year, the limits should be pro-rated.

(B) In case of a managerial person who is functioning in a professional capacity, remuneration as per item (A) may be paid, if such managerial person is not having any interest in the capital of the company or its holding company or any of its subsidiaries directly or indirectly or through any other statutory structures and not having any, direct or indirect interest or related to the directors or promoters of the company or its holding company or any of its subsidiaries at any time during the last two years before or on or after the date of appointment and possesses graduate level qualification with expertise and specialised knowledge in the field in which the company operates:
 
Provided that any employee of a company holding shares of the company not exceeding 0.5% of its paid up share capital under any scheme formulated for allotment of shares to such employees including Employees Stock Option Plan or by way of qualification should be deemed to be a person not having any interest in the capital of the company;

Provided further that the limits specified under items (A) and (B) of this section should apply, if-
  1. payment of remuneration is approved by a resolution passed by the Board and, in the case of a company covered under Section 178(1) also by the Nomination and Remuneration Committee;
  2. the company has not committed any default in payment of dues to any bank or public financial institution or non-convertible debenture holders or any other secured creditor, and in case of default, the prior approval of the bank or public financial institution concerned or the non-convertible debenture holders or other secured creditor, as the case may be, shall be obtained by the company before obtaining the approval in the general meeting.
  3. an ordinary resolution or a special resolution, as the case may be, has been passed for payment of Remuneration as per item (A) or a special resolution has been passed for payment of remuneration as per item (B), at the general meeting of the company for a period not exceeding 3 years.
  4. a statement along with a notice calling the general meeting referred to in clause (iii) is given to the shareholders containing the following information, namely:-
I. General Information:
  1. Nature of industry
  2. Date or expected date of commencement of commercial production.
  3. In case of new companies, expected date of commencement of activities as per project approved by financial institutions appearing in the prospectus
  4. Financial performance based on given indicators
  5. Foreign investments or collaborations, if any.
II. Information about the appointee:
  1. Background details
  2. Past remuneration
  3. Recognition or awards
  4. Job profile and his suitability
  5. Remuneration proposed
  6. Comparative remuneration profile with respect to industry, size of the company, profile of the position and person (in case of expatriates the relevant details would be with respect to the country of his origin)
  7. Pecuniary relationship directly or indirectly with the company, or relationship with the managerial personnel, if any.
III. Other information:
  1. Reasons of loss or inadequate profits
  2. Steps taken or proposed to be taken for improvement
  3. Expected increase in productivity and profits in measurable terms.
IV. Disclosures:

The following disclosures should be mentioned in the Board of Director's report under the heading "Corporate Governance", if any, attached to the financial statement:-
  1. all elements of remuneration package such as salary, benefits, bonuses, stock options, pension, etc., of all the directors;
  2. details of fixed component and performance linked incentives along with the performance criteria;
  3. service contracts, notice period, severance fees;
  4. stock option details, if any, and whether the same has been issued at a discount as well as the period over which accrued and over which exercisable.
Section III - Remuneration payable by companies having no profit or inadequate profit in certain special circumstances

In the following circumstances a company may, pay remuneration to a managerial person in excess of the amounts provided in Section II above:-

(a) where the remuneration in excess of the limits specified in Section I or II is paid by any other company and that other company is either a foreign company or has got the approval of its shareholders in general meeting to make such payment, and treats this amount as managerial remuneration for the purpose of Section 197 and the total managerial remuneration payable by such other company to its managerial persons including such amount or amounts is within permissible limits under Section 197.

(b) where the company-
  1. is a newly incorporated company, for a period of seven years from the date of its incorporation, or
  2. is a sick company, for whom a scheme of revival or rehabilitation has been ordered by the Board for Industrial and Financial Reconstruction for a period of 5 years from the date of sanction of scheme of revival,
  3. is a company in relation to which a resolution plan has been approved by the National Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016 for a period of 5 years from the date of such approval, it may pay any remuneration to its managerial persons.
(c) where remuneration of a managerial person exceeds the limits in Section II but the remuneration has been fixed by the Board for Industrial and Financial Reconstruction or the National Company Law Tribunal:

Provided that the limits under this Section should be applicable subject to meeting all the conditions specified under Section II and the following additional conditions:-
  1. except as provided in para (a) of this Section, the managerial person is not receiving remuneration from any other company;
  2. the auditor or Company Secretary of the company or where the company has not appointed a Secretary, a Secretary in whole-time practice, certifies that all secured creditors and term lenders have stated in writing that they have no objection for the appointment of the managerial person as well as the quantum of remuneration and such certificate is filed along with the return as prescribed under sub-section (4) of section 196.
  3. the auditor or Company Secretary or where the company has not appointed a secretary, a secretary in whole-time practice certifies that there, is no default on payments to any creditors, and all dues to deposit holders are being settled on time.
(d) a company in a Special Economic Zone as notified by Department of Commerce from time to time which has not raised any money by public issue of shares or debentures in India, and has not made any default in India in repayment of any of its debts (including public deposits) or debentures or interest payable thereon for a continuous period of thirty days in any financial year, may pay remuneration up to ` 2,40,00,000 per annum.

Section IV -Perquisites not included in managerial remuneration:

1. A managerial person should be eligible for the following perquisites which should not be included in the computation of the ceiling on remuneration specified in Section II and Section III:-
  1. contribution to provident fund, superannuation fund or annuity fund to the extent these either singly or put together are not taxable under the Income-tax Act, 1961;
  2. gratuity payable at a rate not exceeding half a month's salary for each completed year of service; and
  3. encashment of leave at the end of the tenure.
2. In addition to the perquisites specified in paragraph 1 of this section, an expatriate managerial person (including a non-resident Indian) should be eligible to the following perquisites which should not be included in the computation of the ceiling on remuneration specified in Section II or Section III-
  1. Children's education allowance: In case of children studying in or outside India, an allowance limited to a maximum of ` 12,000 per month per child or actual expenses incurred, whichever is less. Such allowance is admissible up to a maximum of two children.
  2. Holiday passage for children studying outside India or family staying abroad: Return holiday passage once in a year by economy class or once in two years by first class to children and to the members 'of the family from the place of their study or stay abroad to India if they are not residing in India, with the managerial person.
  3. Leave travel concession: Return passage for self and family in accordance with the rules specified by the company where it is proposed that the leave be spent in home country instead of anywhere in India.
Explanation I- For the purposes of Section II of this Part, "Effective capital" means the aggregate of the paid-up share capital (excluding share application money or advances against shares); amount, if any, for the time being standing to the credit of share premium account; reserves and surplus (excluding revaluation reserve); long-term loans and deposits repayable after one year (excluding working capital loans, over drafts, interest due on loans unless funded, bank guarantee, etc., and other short-term arrangements) as reduced by the aggregate of any investments (except in case of investment by an investment company whose principal business is acquisition of shares, stock, debentures or other securities), accumulated losses and preliminary expenses not written off.
Explanation II-
  1. Where the appointment of the managerial person is made in the year in which company has been incorporated, the effective capital should be calculated as on the date of such appointment;
  2. In any other case the effective capital should be calculated as on the last date of the financial year preceding the financial year in which the appointment of the managerial person is made.
Explanation III- For the purposes of this Schedule, "family" means the spouse, dependent children and dependent parents of the managerial person.

Explanation IV- The Nomination and Remuneration Committee while approving the remuneration under Section II or Section Ill, should-
  1. take into account, financial position of the company, trend in the industry, appointee's qualification, experience, past performance, past remuneration, etc.;
  2. be in a position to bring about objectivity in determining the remuneration package while striking a balance between the interest of the company and the shareholders.
Explanation V- For the purposes of this Schedule, "negative effective capital" means the effective capital which is calculated in accordance with the provisions contained in Explanation I of this Part is less than zero.

Explanation VI- For the purposes of this Schedule:-
  1. "current relevant profit" means the profit as calculated under section 198 but without deducting the excess of expenditure over income referred to in sub- section 4 (I) thereof in respect of those years during which the managerial person was not an employee, director or shareholder of the company or its holding or subsidiary companies.
  2. "Remuneration" means remuneration as defined in clause 78 of section 2 and includes reimbursement of any direct taxes to the managerial person.
Section V- Remuneration payable to a managerial person in two companies:

Subject to the provisions of sections I to IV, a managerial person should draw remuneration from one or both companies, provided that the total remuneration drawn from the companies does not exceed the higher maximum limit admissible from anyone of the companies of which he is a managerial person.

Note: The appointment and remuneration referred to in Part I and Part II of this Schedule should be subject to approval by a resolution of the shareholders in general meeting.

Ascertainment of profit for managerial remuneration

As we have seen above that in case of a company having profits, managerial remuneration is calculated as a percentage on net profit. Such net profit is to be arrived in accordance with the provisions of Section 198 of the Companies Act, 2013.

As per Section 198 of the Companies Act, 2013,

(I) In making the computation aforesaid, credit should be given for the bounties and subsidies received from any Government, or any public authority constituted or authorised in this behalf, by any Government, unless and except in so far as the Central Government otherwise directs.

(II) In making the computation of the net profits, credit should not be given for the following sums, namely:—
  1. profits, by way of premium on shares or debentures of the company, which are issued or sold by the company
  2. profits on sales by the company of forfeited shares
  3. profits of a capital nature including profits from the sale of the undertaking or any of the undertakings of the company or of any part thereof
  4. profits from the sale of any immovable property or fixed assets of a capital nature comprised in the undertaking or any of the undertakings of the company, unless the business of the company consists, whether wholly or partly, of buying and selling any such property or assets: Provided that where the amount for which any fixed asset is sold exceeds the written-down value thereof, credit should be given for so much of the excess as is not higher than the difference between the original cost of that fixed asset and its written-down value
  5. any change in carrying amount of an asset or of a liability recognised in equity reserves including surplus in profit and loss account on measurement of the asset or the liability at fair value
(III) In making the computation aforesaid, the following sums should be deducted, namely:—
  1. all the usual working charges
  2. directors’ remuneration
  3. bonus or commission paid or payable to any member of the company’s staff, or to any engineer, technician or person employed or engaged by the company, whether on a whole-time or on a part-time basis
  4. any tax notified by the Central Government as being in the nature of a tax on excess or abnormal profits
  5. any tax on business profits imposed for special reasons or in special circumstances and notified by the Central Government in this behalf
  6. interest on debentures issued by the company
  7. interest on mortgages executed by the company and on loans and advances secured by a charge on its fixed or floating assets
  8. interest on unsecured loans and advances
  9. expenses on repairs, whether to immovable or to movable property, provided the repairs are not of a capital nature
  10. outgoings inclusive of contributions made under section 181 of the Act
  11. depreciation to the extent specified in section 123 of the Act
  12. the excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year which begins at or after the commencement of this Act, in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained
  13. any compensation or damages to be paid in virtue of any legal liability including a liability arising from a breach of contract
  14. any sum paid by way of insurance against the risk of meeting any liability such as is referred to in clause (m)
  15. debts considered bad and written off or adjusted during the year of account
(IV) In making the computation aforesaid, the following sums should not be deducted, namely:—
  1.  income-tax and super-tax payable by the company under the Income- tax Act, 1961, or any other tax on the income of the company not falling under clauses (d) and (e) of sub-section (4)
  2. any compensation, damages or payments made voluntarily, that is to say, otherwise than in virtue of a liability such as is referred to in clause (m) of sub-section (4)
  3. loss of a capital nature including loss on sale of the undertaking or any of the undertakings of the company or of any part thereof not including any excess of the written-down value of any asset which is sold, discarded, demolished or destroyed over its sale proceeds or its scrap value
  4. any change in carrying amount of an asset or of a liability recognised in equity reserves including surplus in profit and loss account on measurement of the asset or the liability at fair value


7. DIVISIBLE PROFIT

One of the important functions of company accounting is to determine the amount of profits which is available for distribution to the shareholders as dividend. This is necessary since the amount of profits disclosed by the Profit & Loss Account, in every case, is not available for distribution. The availability of profits for distribution depends on a number of factors, e.g., their composition, the amount of provisions and appropriations that must be made out of them in priority, etc.

Meaning of Dividend
  1. A dividend is a distribution of divisible profit of a company among the members according to the number of shares held by each of them in the capital of the company and the rights attaching thereto.
  2. Such a distribution may or may not entail a release of assets; it would be where a distribution involves payment of cash.
  3. But when profits are capitalised and the amount distributed is applied towards payment of bonus shares, issued free to the shareholders, no part of the assets of the company can be said to have been released since, in such a case, profits are only capitalised, thereby increasing the paid up capital of the company. The company does not give up any asset.
As per Section 2 (35) of the Companies Act, 2013, term “Dividend” includes interim dividend also.

Under Section 123 (1) of the Companies Act, 2013, no dividend should be declared or paid by a company for any financial year except-
  1. Out of the profits of the company for that financial year arrived at after providing for depreciation in accordance with the provisions of section 123(2), or
  2. Out of the profits for any previous financial years arrived at after providing for depreciation in accordance with the provisions of that sub section and remaining undistributed; or
  3. Out of both the above;
  4. Out of the moneys provided by the Central Government or any State Government for the payment of dividend by the Company in pursuance of any guarantee given by that government
Provided that no dividend should be declared or paid by a company from its reserves other than free reserves.

Declaration of a dividend presupposes that there is a trading profit or a surplus available for distribution, arrived at after providing for depreciation on assets, not only for the year in which the profits were earned but also for any arrears of depreciation of the past years, calculated in the manner prescribed by sub-section (2) of Section 123.

Sub-section (3) of Section 124 further states 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 in which such interim dividend is sought to be declared: Provided 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 should not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years.

Dividends cannot be declared except out of profits.
Capital cannot be returned to the shareholders by way of dividend.

Dividend can be declared and paid by a company only out of the profits or free reserves (other than moneys provided by Central or State Govt.) as the payment of dividend from any other source will amount to payment of dividend from capital units.
 
Provision for Depreciation

Section 123(2) provides that depreciation must be to the extent specified in Schedule II to the Companies Act, 2013.Further, when the assets are sold, discarded, demolished or destroyed in any financial year, the excess of the written down value over its sale proceeds as scrap, if any should be written off in the same financial year.

Declaration and Payment of Dividend

For the purpose of second proviso to sub-section (1) of section 123, a company may declare dividend out of the accumulated profits earned by it in previous years and transferred by it to the reserves, in the event of inadequacy or absence of profits in any year, subject to the fulfilment of the following conditions as per Companies (Declaration and Payment of Dividend) Rules, 2014:
  1. The rate of dividend declared should not exceed the average of the rates at which dividend was declared by it in the three years immediately preceding that year: provided that this sub-rule should not apply to a company, which has not declared any dividend in each of the three preceding financial years.
  2. The total amount to be drawn from such accumulated profits should not exceed one-tenth of the sum of its paid-up share capital and free reserves as appearing in the latest audited financial statement.
  3. The amount so drawn should first be utilised to set off the losses incurred in the financial year in which dividend is declared before any dividend in respect of equity shares is declared.
  4. The balance of reserves after such withdrawal should not fall below 15% of its paid up share capital as appearing in the latest audited financial statement.
  5. No company should declare dividend unless carried over previous losses and depreciation not provided in previous year are set off against profit of the company of the current year the loss or depreciation, whichever is less, in previous years is set off against the profit of the company for the year for which dividend is declared or paid.
Transfer to Reserves

I The Board of Directors are free and can appropriate a part of the profits to the credit of a reserve or reserves as per section 123 (1) of the Companies Act, 2013.

II Appropriation of a part of profit is sometimes made under law.
  1. For example, under the Banking Regulation Act, a fixed percentage of the profit of a banking company must first be transferred to the General Reserve before any dividend can be distributed.
  2. Transfer of a part of profit to a reserve is also necessary where the company has undertaken, at the time of raising of loan, that before any part of its profit is distributed, a specified percentage of the profit every year should be credited to a reserve for the repayment of the loan and until the time for repayment arrives, the amount should remain invested in a specified manner.
III Apart from appropriations aforementioned, it may also be necessary to provide for losses and arrears of depreciation and to exclude capital profit, as mentioned earlier, to arrive at the amount of divisible profit.

Declaration of Dividend

As per Section 123 of the Companies Act, 2013, Board of Directors of a company may declare dividend including interim dividend during any financial year out of the surplus in the profit and loss account and out of profits of the financial year in which such interim dividend is sought to be declared:

Provided 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 should not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years.

The amount of the dividend, including interim dividend, should be deposited in a scheduled bank in a separate account within five days from the date of declarat ion of such dividend.

No dividend should be paid by a company in respect of any share therein except to the registered shareholder of such share or to his order or to his banker and should not be payable except in cash: Provided that nothing in Section 123 should be deemed to prohibit the capitalisation 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 being unpaid on any shares held by the members of the company:
 
Provided further that any dividend payable in cash may be paid by cheque or warrant or in any electronic mode to the shareholder entitled to the payment of the dividend.

Dividend on preference shares
  1. Holders of preference shares are entitled to receive a dividend at a fixed rate before any dividend is declared on equity shares.
  2. But such a right can be exercised subject to there being profits and the Directors recommending payment of the dividend.
Dividend on partly paid shares:

A company may if so authorised by its Article, pay a dividend in proportion to the amount paid on each share (Section 51 of the Companies Act, 2013).

Calls in Advance

Calls paid in advance do not rank for payment of dividend.

Payment of Dividend

As per Section 124 of the Companies Act, 2013:
  1. Where a dividend has been declared by a company but has not been paid or claimed within thirty days from the date of the declaration to any shareholder entitled to the payment of the dividend, the company should, within seven days from the date of expiry of the said period of thirty days, transfer the total amount of dividend which remains unpaid or unclaimed to a special account to be opened by the company in that behalf in any scheduled bank to be called the Unpaid Dividend Account.
  2. The company should, within a period of ninety days of making any transfer of an amount under this section to the Unpaid Dividend Account, prepare a statement containing the names, their last known addresses and the unpaid dividend to be paid to each person and place it on the website of the company, if any, and also on any other website approved by the Central Government for this purpose, in such form, manner and other particulars as may be prescribed.
  3. If any default is made in transferring the total amount or any part thereof to the Unpaid Dividend Account of the company, it should pay, from the date of such default, interest on so much of the amount as has not been transferred to the said account, at the rate of 12% per annum and the interest accruing on such amount should ensure to the benefit of the members of the company in proportion to the amount remaining unpaid to them.
  4. Any person claiming to be entitled to any money transferred to the Unpaid Dividend Account of the company may apply to the company for payment of the money claimed.
  5. Any money transferred to the Unpaid Dividend Account of a company in pursuance of this section which remains unpaid or unclaimed for a period of seven years from the date of such transfer should be transferred by the company along with interest accrued, if any, thereon to the Fund “Investor Education and Protection Fund” established section 125 and the company should send a statement in the prescribed form of the details of such transfer to the authority which administers the said Fund and that authority should issue a receipt to the company as evidence of such transfer.
  6. All shares in respect of which unpaid or unclaimed dividend has been transferred to “Investor Education and Protection Fund” should also be transferred by the company in the name of Investor Education and Protection Fund along with a statement containing such details as may be prescribed:
    Provided that any claimant of shares transferred above should be entitled to claim the transfer of shares from Investor Education and Protection Fund in accordance with such procedure and on submission of such documents as may be prescribed.
  7. If a company fails to comply with any of the requirements of this section, the company will be punishable with fine which will not be less than five lakh rupees but which may extend to twenty-five lakh rupees and every officer of the company who is in default will be punishable with fine which will not be less than one lakh rupees but which may extend to five lakh rupees.
Ruchika Saboo An All India Ranker (AIR 7 - CA Finals, AIR 43 - CA Inter), she is one of those teachers who just loved studying as a student. Aims to bring the same drive in her students.

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She believes - "When you study, you get wise, you obtain knowledge. A knowledge that helps you in real life, in solving problems, finding opportunities. Implement what you study". She has a huge affinity for the Law Subject in particular and always encourages student to - "STUDY FROM THE BARE ACT, MAKE YOUR OWN INTERPRETATIONS". A rare practice that you will find in her video lectures as well.

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Yashvardhan Saboo A Story teller, passionate for simplifying complexities, techie. Perfectionist by heart, he is the founder of - Konceptca.

Yash Sir (As students call him fondly) is not a teacher per se. He is a story teller who specializes in simplifying things, connecting the dots and building a story behind everything he teaches. A firm believer of Real Teaching, according to him - "Real Teaching is not teaching standard methods but giving the power to students to develop his own methods".

He cleared his CA Finals in May 2011 and has been into teaching since. He started teaching CA, CS, 11th, 12th, B.Com, M.Com students in an offline mode until 2016 when Konceptca was launched. One of the pioneers in Online Education, he believes in providing a learning experience which is NEAT, SMOOTH and AFFORDABLE.

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