Part E Capital and the financing of companies 17: Capital maintenance and dividend law 2613.2 Distributable profit
Distributable profits may be defined as 'accumulated realised profits ... less accumulated realised losses'.
'Accumulated' means that any losses of previous years must be included in reckoning the current
distributable surplus. 'Realised' profits are determined in accordance with generally accepted accounting
principles.Profits available for distribution are accumulated realised profits (which have not been distributed or
capitalised) less accumulated realised losses (which have not been previously written off in a reduction or
reorganisation of capital).The word 'accumulated' requires that any losses of previous years must be included in reckoning the
current distributable surplus. A profit or loss is deemed to be realised if it is treated as realised in
accordance with generally accepted accounting principles. Hence, financial reporting and accounting
standards in issue, plus generally accepted accounting principles (GAAP), should be taken into account
when determining realised profits and losses.
Depreciation must be treated as a realised loss, and debited against profit, in determining the amount of
distributable profit remaining.
However, a revalued asset will have deprecation charged on its historical cost and the increase in the
value in the asset. The Companies Act allows the depreciation provision on the valuation increase to be
treated also as a realised profit. Effectively there is a cancelling out, and at the end only depreciation that
relates to historical cost will affect dividends.Illustration^
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Suppose that an asset purchased for £20,000 has a ten year life. Provision is made for depreciation on a
straight line basis. This means an annual depreciation charge of £2,000 (£20,000/10 years) must be
deducted in reckoning the company's realised profit less realised loss.
After five years the asset is written down value is £10,000 (£20,000 less £2,000 × 5 years). Suppose that
the asset is then revalued to £50,000. The increase in the value of the asset (£40,000) is credited to the
revaluation reserve.
The consequences of this revaluation are that the annual depreciation charge is raised to £10,000
(£50,000/5 remaining years of the asset's life) and £8,000 (£40,000/5 years) is transferred from the
revaluation reserve to realised profit each year for the remaining life of the asset.
The net effect is that each year realised profits are still reduced by £2,000 (£10,000 – £8,000) in respect of
depreciation.
If, on a general revaluation of all fixed assets, it appears that there is a diminution in value of any one or
more assets, then any related provision(s) need not be treated as a realised loss. The Act states that if a
company shows development expenditure as an asset in its accounts it must usually be treated as a
realised loss in the year it occurs. However it can be carried forward in special circumstances (generally
taken to mean in accordance with accounting standards).
3.3 Dividends of public companies
A public company may only make a distribution if its net assets are, at the time, not less than the
aggregate of its called-up share capital and undistributable reserves. It may only pay a dividend which
will leave its net assets at not less than that aggregate amount.
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