PROFIT AND DIVISIBLE PROFIT

Introduction
Role of an auditors for auditing divisible profit
Principle of Divisible Profit
Verification of legality of profitability items related to “ Divisible
Profit”

Roll no.:- 8506/8552 (S.Y.M.com) Advanced Auditing

 PROFIT
Profit is the financial gain from business activity minus expenses.

Profit is the income remaining after costs are deducted from the total
revenue.

It is the positive gain, because it denotes the basis on which tax is
computed and dividend is paid.

It is most commonly used as a measure of success of a business.

 DIVISIBLE PROFIT
 Divisible profit means the profit available to distribution in the form of
dividend to the shareholders.

 Divisible profit must be computed after making any deduction which the
directors can duly make.

 Dividend shall be declared only out of the profit of the company after
deducting depreciation.

 Out of the accumulated balance of profit of the early years remaining

undistributed after provision for depreciation is made.
A) As per section 205 of the Companies Act, 1956, Divisible Profit means:
Important provisions are,
a) No dividends should be declared or paid by a company for any financial year except:
1)Out of current year profit
2)Out of previous year profit
3)Out of both
Out of (1) (2) (3) after deduction of current Depreciation, Arrears of Depreciation,
Previous year losses.

b) Payment of dividend only in Cash.

c) No payment of dividend out of Capital.
d) Payment of dividend within 30 days.
B) As per Income Tax Act ‘Divisible Profit’ means:
Section 109 of this Act provides for declaration of a statutory percentage of distributable
income as under in respect of the following classes of companies:

 45% in the case of a consultancy service company.

 90% in the case of an investment company.
 60% in the case of other companies.
It also states that the company must have to pay additional income tax if such statutory
distribution is not made.

C) Legal Decisions:
As per guidelines given by the Decided Legal Cases Divisible Profit means:

The management of company and the auditors should consider these legal decisions as
sources of guidance to arrive at the divisible profit while recommending or computing
dividend.
 ROLE OF AN AUDITIOR FOR AUDITING DIVISIBLE PROFIT
• Following profits should be considered by the auditor while auditing of Divisible Profit:
i. Dividend can be distributed out of profits of the company.
ii. The capital of the shareholders should in no case be used for the purpose of
distribution as dividend.
iii. Depreciation on fixed assets must be provided as per Section 205 before computing
divisible profits.
iv. Depreciation on floating assets must also provided before computing divisible
profits.
v. A company may pay dividends out of profits of the current year without making
good a loss of fixed capital provided there are sufficient assets to pay off liabilities.
vi. A company can not pay dividends if the security of the creditors is doubted in any
way.
vii. A company need not distribute the whole of the profit amongst its shareholders .
viii. The following deductions should be made out of the divisible profits to distribute it as
dividends:
• Under section 205(2): Current Depreciation
• Under section 205 (2a): Transfer of General Reserve
• Under Section 205 (a): Arrears of Depreciation
• Under Section 252 (b): Past losses.

ix. The accounting principles such as:

• Going Concern Concept
• Consistency Concept
• Conservatism Concept
• Matching Concept must be applied while calculation of profits to be distributed as
dividends.
 PRINCIPLES OF DIVISIBLE PROFIT
1. According to the 6. Undistributed 11. Loss of Previous 16. Solvency of
Company Rules Profit Year company

2. Follow the Court 7. Depreciation 12. Revaluation of 17. Creditors

Cases Assets Protection

3. Profit Not Out of 8. Secrete Reserves 13. Revenue Profits

Capital

4. Approval of 9. Capital Profits 14. Asset Goodwill

Shareholders Written Down and Up
5. Right of Proposal 10. Capital Loss 15. Profit for to
Incorporation
 Verification of legality of profitability items related to “Divisible Profit”
Auditor should verify the following items related to Divisible Profit:
a) Share Premium:-
In accordance with the company law, a company has to transfer share premiums to
Share Premium Account. The receipts of premiums, thus, cannot be distributed as
Dividend.

b) Sale of Companies Fixed Assets:

Profit or Loss on sale of assets is taxable under the head “Capital Gain”.
Profit on the sale of company’s assets is not earned during normal business operations.
Hence, it is capital profit. This is available for distribution as dividend subject to the
conditions that:
I. Such distribution is authorised by the Articles of Association, and
II. Such surplus in actually realised in cash. This profit is on capital and not a part of capital.
c) Capital Redemption Reserve:
This represents an amount transferred from profits available for dividend, equal to the
nominal amount of any redeemable preference shares otherwise than out of the proceeds
of a fresh issue of share.
This Section further stipulates that a reduction of this reserve can be made only in the
manner in which the share capital pf a company can be reduced.
This reserve is not available for distribution as dividend.

d) Fixed Assets Revaluation Reserve:

This reserve is created by writing-up the fixed assets of a company as a result of
revaluation.
According to the present company legislation, the unrealized appreciation in the value of
fixed assets is not available for dividend distribution.
e) Forfeiture and Re-Issue of Shares:
Where forfeited shares are re-issued, the amount realised in excess of the nominal
value of the shares is transferred to the Capital Reserve, and the premiums received on
the original issue of shares remain in the Share Premium Account.
The amount received on the forfeited shares is credited to the Forfeited Shares Account
and shown in the Balance sheet under: Share Capital.
This amount on credit can be applied to write off:
I. Discount on the re-issue of shares, or
II. Fictitious assets like preliminary expenses.
Thus, this amount is not distributable as dividend
f) Development Rebate Reserve :
This Reserve, thus, cannot be utilised for payment of dividend for at least eight year.
It is reserve created out of the development rebate granted under provisions of Income
Tax.

g) Tax Exempt Profits Reserve:

This is a Revenue Reserve and not a Capital Reserve. It can, therefore, be distributed as
dividend.

h) Sales Promotion Reserve:

It is an amount set aside for sales promotion purpose of a company, and therefore, a
revenue reserve. The whole or a part of the amount, if unutilized, can be distributed as
dividend.
i) Capital Profit:
Auditor considers following legal view points regarding distribution of ‘Capital Profit’.

These refer to those profits which are not earned during the normal business operations.
That means, these result from other sources and are not traceable as trading profits.
The examples of capital profit are:
1. Premium received on the issue of shares or debentures.
2. Profit earned on the sale of fixed assets.
3. Profit earned on the redemption of debentures by purchase at a discount.
4. Profit earned on the resale of the forfeited shares.
5. Profit earned prior to incorporation of a company.