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32. Limited Companies - Appropriation of

Profits
Dividends
When profits are divided among the shareholders of a company, each shareholder
receives a portion of the profits called dividends. The dividends are proposed or
recommended by the directors and declared by the company in the annual general
meeting, the shareholders usually having to sanction to the proposed distribution of
profits.
Dividends are calculated on the paid-up capital of the company and are usually
expressed as a percentage, e.g. a dividend of 10% on 4,000,000 Ordinary Shares of $1
each means that $400,000 will be paid out for ordinary share dividend; and a share
holder having 30,000 ordinary shares will receive $3,000 as cash dividends.
Below is an example of the annual payment of dividends to the different classes of
shares over a period of seven years.

Year

Preference Shares
Total Profits
Appropriated Dividends
Rate of
for Dividends Appropriated
Dividend

Ordinary Shares
Dividends
Appropriated

Rate of
Dividend

6,000

6,000

6%

14,000

6,000

6%

8,000

4%

18,000

6,000

6%

12,000

6%

22,000

6,000

6%

16,000

8%

10,000

6,000

6%

4,000

2%

26,000

6,000

6%

20,000

10%

30,000

6,000

6%

24,000

12%

The example above shows that the preference shares enjoy a fixed rate of dividend
whether profits are high or low. On the other hand, ordinary shares are paid a rate
that varies with the profits made, i.e. a higher rate when profits are higher and a
lower rate when insufficient profits are earned. In year 1, the profits made were only
sufficient to pay the preference shares their rate of dividend.

Interim Dividends
Instead of making one payment for he dividend, a company may choose to pay part of
the dividend half way through the year. This part payment of dividend is
called interim dividend. These dividends can be paid even before profits are known
as they are paid out of undistributed profits brought forward from previous periods.

Final Dividends
Final dividends are dividends declared at the end of the financial period only after
profits are determined. Usually, the final dividends are declared before the books are
closed and will be paid the following year. Thus, final dividends will appear as
dividends payable or proposed dividends under current liabilities in the Balance Sheet
of that period while the interim dividends will not appear in the same Balance Sheet
as they have been paid during the current year.
A company that chooses to make only one payment for dividend usually declares a
first and final dividend at the end of the accounting period.
In the case of preference shares, the interim dividend combined with the final
dividend cannot exceed the fixed rate of dividend agreed upon.
Ordinary shares, on the other hand, do not have such restriction as the rate of dividend
is variable.
However, a company may adopt a policy of maintaining a relatively stable rate of
ordinary share dividend even though annual profits may vary.

Preparation of Company Final Accounts

Trading and Profit and Loss Accounts
The Trading and Profit and Loss Accounts of a limited company have
features similar to those of other business units except that the Profit and Loss
Account has two sections:

1. Section I contains the usual items presented in the normal way, expenses on the
debit side and revenue on the credit side. The net operating profit is
determined in this section and then brought down to Section II.
2. Section II contains items which affect the profit but are not due directly to the
normal activities of the business. Income derived from transactions outside the
ordinary activities of the business, e.g. income from investment will be credited
to this section and added to the net operating profit brought down from the first
section. Expenses like auditor's fees, debenture interest and directors'
remuneration will be debited to this section of the Profit and Loss Account to
be charged against profits. The net profit (or loss) for the year is then
ascertained and carried down to the Appropriation Account.
Appropriation Account
The purpose of setting up the Appropriation Account is to show the manner in which
profits are appropriated or distributed.
On the credit side of the Appropriation Account, the net profit brought down from the
Profit and Loss Account will be added to the undistributed profit brought forward
from the previous year to give the total profits available for appropriation.
All the appropriation of profits that is to be made is debited to the account. This
appropriation is as follows:
1. Transfers to Reserves
It is the practice to set aside some of the profits as reserves so as to strengthen the
general financial position of the company. These reserves are called general
reserves. Specific reserves may be created when necessary for a specific
purpose, e.g. a company may set up a redemption of debenture reserve to provide
for the repayment of its debentures at a certain date in the future.
Both general and specific reserves are classified as revenue reserves as they are
reserves created from operating or trading profits and these reserves are available
for distribution of dividends in the future.
2. Dividends
Dividends are paid out of profits to the various classes of shares (preference,
ordinary and so on) at their different rates. Here, dividends that have been paid (as

in the case of interim dividends) and those that have not been paid but have been
proposed (as in the case of final dividends) will be shown.
3. Other Appropriation
Other appropriation includes preliminary expenses or expenses incurred upon
formation of the company, goodwill written off and funds created for specific
purposes, e.g. Staff Pension Fund and Dividend Equalization Fund.
The balance remaining after the above appropriation of profits has been made
represents the unappropriatied profits of the year. It is usual to leave part of the
profits unappropriated and to carry forward these profits to the following year's
appropriation. The unappropriated profit serves to stabilize the payment of
dividends over the years.
The Appropriation Account is shown as follows:

An Example of The Appropriation Account

Balance Sheet
The Balance Sheet of a limited company must contain a summary of the company's
assets and liabilities. On the assets side:
1. Fixed Assets
The different types of fixed assets must be clearly shown under separate headings.
The fixed assets of a company include buildings and other properties of a
permanent nature, plant and machinery, fixtures and fittings, office furniture and
equipment, motor vehicles, goodwill, patents and trade-marks.

The company has to show now it arrives at the final or net values of the fixed
assets.
2. Investments
There should be a separate heading for investment. The company is required to
show the details of the various investments (e.g. whether quoted or unquoted at the
Stock Exchange) it has made outside the company.
3. Current Assets
Current assets include stock, debtors, prepaid expenses, cash at the bank and cash
in hand.
4. Fictitious Assets
These include preliminary expenses, expenses of issuing shares or debentures,
discount on issue of shares or debentures and commission paid on shares or
debentures. These items must be presented in the Balance Sheet so long as they are
not written off.
On the owner's equity and liabilities side:
1. Share Capital
(a) Authorized Capital - the various types of shares it is made up of and their
description.
(b) Issued Capital - the description of the different types of shares issued, their
number and nominal values and the amount called up and paid up.
2. Reserves
There are two main types of reserves:
(a) Capital reserves are reserves which are created out of capital profits, e.g.
premium on shares or debentures. These reserves are not available for distribution
as dividends but may be used to write off discount on shares and debentures.
(b) Revenue reserves are reserves created from operating profits which are
retained in the business and for the present, are not available for distribution as
dividends. Revenue reserves include those profits retained in the business in the

form of reserves as well as the unappropriated profits in the Appropriation

Account.
The revenue reserves that are retained in the business can be general or specific.
The general reserves are 'free' as they are not meant for any specific purpose, while
the specific reserves are set aside for a particular purpose, e.g. for the redemption of
debentures.
Reserves are similar to provisions in that both are amounts set aside out of profits.
While reserves are not intended to meet any known contingency or liability or loss
at the time when the Balance Sheet is prepared, provisions refer to the amount
retained for a known liability, the amount of which cannot be determined with
substantial accuracy. Provisions may be made for depreciation, bad debts and
discounts on debtors.
The provisions are shown as deductions against the relevant asset or liability in the
Balance Sheet, e.g. provision for depreciation is shown as a deduction against a
fixed asset, provision for bad debts against debtors and provision for discount
allowed against debtors.
3. Long-term Liabilities
Debentures represent a major part of the long-term loans of a limited company.
Should the company wind up, the shareholders of secured debentures will have the
right to the proceeds of the sale of particular assets of the company. Other longterm liabilities include loans from banks, finance companies and other sources.
The terms of repayment and the rate of interest should be so stated for the above
liabilities in the Balance Sheet.
4. Current Liabilities
Sundry creditors, amounts due but not yet paid, bank overdraft, proposed share
dividends and debenture interest not yet paid and taxation due are some of the
current liabilities of the company. These liabilities are short term in nature as they
are usually paid up within an accounting periods.
The following shows an example of a published Balance Sheet:

An Example of A Published Balance Sheet of a Limited Company

Vertical Presentation
Presentation of the final accounts, Appropriation Account and Balance Sheet in the
vertical form instead of in the form of an account is becoming increasingly
popular (as in the O'Level Examinations).
When this method is used, it is common to arrange the items in columnar fashion and
use instructional words like 'add' and 'less' so that the method of ariving at the final
answer can easily be understood.
The following is a vertical presentation of the Profit and Loss Appropriation Account
and Balance Sheet shown above -

Vertical Presentation of The Profit and Loss Appropriation Account

Vertical Presentation of The Balance Sheet of a Limited Company

Summary
Dividend is a share of profits made by the company.

 Interim dividends are dividends payable before the close of the financial
period, i.e. before the profits for the financial period have been determined.
Final dividends are dividends declared at the end of the financial period,
only after profits are determined.
An Appropriation Account is prepared to show how profits are appropriated
or distributed.