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Dividend Decision 5
Dividend Decision 5
Meaning of dividend
Dividend is the term derived from the ‘dividendum’ which means total divisible sum.
Dividend refers to the periodic payments to shareholders of the firm out of the divisible profits.
It is a share in total profits of the company distributed to equity shareholders.
In other words, dividend is that amount of profits used to distribute to shareholders on their
shareholding. It is a periodic return to shareholders on their investment in the company’s
shares.
It is company’s rules and regulations to decide amount of profits used for dividend payment
and amount of profits retained as retained earnings.
The right to recommend a dividend lies with the Board of directors. Only when the Board
recommends a dividend, the shareholders can declare a dividend in the general meeting.
However, the shareholders cannot insist the directors to recommend. Even if there are sufficient
profits, but the directors feel that a distribution of dividend is undesirable in the interests of the
financial stability of the company, they can refuse to recommend a dividend.
Only the shareholders in the Annual General Meeting can declare the dividend. The Board of
Directors determines the rate of dividend to be declared and recommends it to the
shareholders. The shareholders, by passing a resolution in general meeting, can declare the
dividend.
The shareholders can either accept the same rate of dividend or they can even reduce the rate.
However, they cannot enhance the rate of dividend recommended by the directors.
The company can declare and pay a dividend only where there is a profit. In other words,
dividend is payable only out of profits. If there is no profit, there can be no distribution of
dividend. The Companies Act provides that a dividend can be paid only:
3. Out of moneys provided by the Central or State Governments for the purpose of paying a
dividend.
It is already stated that a dividend can be declared only out of profits. The profits should be
arrived only after providing for depreciation for the current year and also for all the arrears of
depreciation or loss in any previous year [Sec. 205 of Companies Act]. However, the Central
Government can exempt any company from this obligation in the interest of the public.
If any loss is incurred in any previous year after 1960, such loss should be set off against the
profits of the current year before declaring a dividend [Sec. 205(1)(b)].
The dividend is payable only in cash. However, a company is not prohibited from capitalizing
its profits or reserves by the issue of bonus shares or by making partly paid up shares into fully
paid up shares.
7. Transfer to Reserves
It is also provided in the Companies Act that every company before declaring any dividend
should transfer a certain percentage not exceeding 10% of the profit, to the reserves of the
company. The percentage shall be prescribed by the Central Government.
Separate rates are prescribed if the company declares the dividend out of the current year’s
profits. The Table below shows the percentages of profits to be transferred compulsorily to
reserves before declaration of any dividend as per the provision of the Companies (Transfer of
Profits to Reserves) Rules, 1975.
1. Above 10% but below 12.5% of the paid up Not less than 2.5% of the current profits
capital
2. Above 12.5% but below 15% Not less than 5% of the current profits
3. Above 15% but below 20% Not less than 7.5% of the current profits
However, the companies are at liberty to transfer a higher percentage of profit to the reserves.
The Companies Amendment Act introduced this provision only in the year 1974 by
incorporating Sec. 205 A in it.
When a dividend is declared, it should be paid within 42 days from the date of declaration. The
dividend when declared shall become a debt due from the company. If the company does not
pay the dividend within the period, every person who is a party to the default is punishable
with simple imprisonment up to seven days and also with a fine.
If a dividend is declared but not paid within 7 days from the date of expiry of the 42 days,
should transfer the amount of unpaid dividend to a separate account with any Scheduled Bank
opened under the style “Unpaid Dividend Account of………Company Ltd“.
Any amount transferred to the Unpaid Dividend Account, which remains unpaid or unclaimed
for a period of three years, should be transferred by the company to the General Reserve
Account of the Central Government. However, the person to whom the dividend is payable can
claim the money from the Central Government. The company which transfers any amount to
the General Reserve Account should furnish a statement furnishing the nature of amount,
names of the persons entitled to receive the amount, their addresses, amount due to them, etc.
1. Legal constraints:
While designing a dividend policy the companies have to consider provisions of
company’s act, Income tax act, SEBI Guidelines. Under companies act , dividend canbe
paid out of current profit or past profits after providing for depreciation. Again , under
the act companies have to transfer a prescribed percentage of profit o general reserve, if
the rate of dividend exceeds certain percentage of paid up capital.
For ex: if the rate of dividend is below 10% of paid up capital, then the company has to
transfer 2.5%to general reserve, if the rate of dividend is more than 20% at least 10% of
net profits be transferred to general reserve. Dividend cannot be paid out of capital.
2. Requirement of shareholders:
Shareholders expectations should be considered while planning the dividend policy. Not
all investors are alike. Some investors prefer constant regular return on their investment
and some investors prefer capital appreciation. So while designing dividend policy the
management has to consider the nature of investors.
If the shareholders expect constant regular return then regular cash dividend policy is
preferable. On the other hand, if the shareholders prefer capital appreciation in that case
regular stock dividend policy is suitable.
5. Investment opportunities:
Investment made in buying financial instruments such as new shares, bonds, securities,
etc. is considered as a financial investment. Investment made in plant and equipment,
land & Building and other infrastructure facilities is considered as real investment.
A company should identify appropriate invest opportunities and invest in them so that
it provides the basis for the firm’s earning power and value. Therefore a company can
utilize present and past profits to invest in profitable ventures, however if investment
opportunities are inadequate it is better to pay dividends and raise external funds
whenever necessary for such opportunities.
6. Economic conditions:
Economic conditions are considered to be sound or positive when an economy is
expanding and are considered to be adverse or negative when an economy is
contracting. Therefore if the economy is going through period of recession most the
firms face problem of low sales and declining profits and therefore as a precautionary
measure may not declare dividends to protect themselves from cash crunch.
8. Stability of earnings:
The size and nature of earnings of a company determine the type of dividend policy.
If the company earns stable & regular earnings then the company can follow stable &
regular dividend policy. On the other hand, if the earnings are not stable & more
irregular then the company cannot follow stable & regular dividend policy. The size of
the earnings also decides the nature of dividend policy.
In other words stable dividend means that a certain minimum amount of dividend is paid
regularly. It may also mean that dividend is paid regularly by the company, but the amount
or rate of dividend is not fixed. The stable dividend may take the following forms:
5. No dividend policy:
Even though dividends plays an important role in rewarding shareholders, but some
companies view in broader context of the varying liquidity needs of the company and
their vision of the company future. A company implements no dividend policy due to
lack of liquidity because of its unfavorable working capital position. Further
management wants the business to grow and the stock to appreciate and in order to do
these prefer reinvesting excess cash in the business rather than growing away on
dividends.
Forms of dividend:
Dividends can be paid by the company in any of the following modes; some of them are
common forms and some o f they are optional such as:
1. Cash dividend: As cash dividend is a dividend paid in cash and it is the most
common method of paying the dividend followed by most of the corporations. In order
to pay dividend in the form of cash companies must have not only sufficient profits but
also sufficient liquid cash.
2. Property dividend: A company may sometimes rather than paying cash dividend
may issue a non monetary dividend to investors. Thus, a property dividend is an non
reciprocal transfer of non monetary assets from a company and its shareholders. It is
payable in form of assets from a company and its shareholders. It is payable in form of
assets other than cash. A property dividend can in the form of real estate, investments or
inventories that the company holds or it can either be in form of shares of its subsidiary
company.
3. Scrip dividend: Scrip is a provisional certificate issued by a company to its
shareholders the certificate states a promise made by the company to the shareholders to
pay them dividend at further specific date. Companies usually opt to distribute scrip
dividend due non availability of liquid cash. Since the company postpones dividend
therefore promissory note may or may not include interest to pay shareholders at a later
date.
4. Stock dividend: Stock dividend is in the form of additional shares, rather than cash.
Usually when company pay dividend in the form of additional or bonus shares when it
doesn’t have sufficient money. In some countries dividend paid in the form of cash is
taxable, however in India dividend received from a Indian company by the shareholders
is exempted from tax under section 10(34) of income tax act. On the other hand when a
company issues stock dividend rather than cash there usually not taxed until the shares
are sold.
5. Bond dividend: When a company pays dividend in the form of debentures or bonds
of the company, it is called bond dividend. Company pays bond dividend when their
cash position is very weak and they don’t want to lose control over company by paying
dividend in company’s equity shares. Through bond dividend companies liquidity is
maintained and at the same time, they keep control over company and shareholders
expectations for dividend.
6. Interim dividend: The dividend declared & paid in between two final dividends or
between two annual general meetings is called as interim dividend. In contrast to final
dividend, Board of directors in board meeting declares an interim dividend. The final
dividend is decided and sanction in annual general meeting of shareholders.
Archana S, Dept of Commerce & Management Page 10
Dividend Decision
7. Final dividend: The dividend paid at the end of accounting year is called the final
dividend. It is the dividend declared & sanctioned at annual general meeting of
shareholders. It is the dividend declared & paid finally out of divisible profits. At the
end of accounting year, final accounts are prepared to ascertain the final trading results
of company. Out of net profits of the company annual dividend is paid.
The following is the list of reserves which can be used for issuing bonus shares