1. Connolly – International Financial Accounting and Reporting – 4 th Edition CHAPTER 18 DISTRIBUTION OF PROFITS AND ASSETS

2. Connolly – International Financial Accounting and Reporting – 4 th Edition 18.1 INTRODUCTION The principle of capital maintenance is fundamental to the protection of creditors of limited liability companies since shareholders may deplete the equity or capital of a company by withdrawing excessive dividends In simple terms, an entity has maintained its capital if it has as much capital at the end of the period as it had at the beginning of the period Capital maintenance – the financial concept or the physical concept The rules regarding the distribution of profits are set out in company legislation and are unchanged by the transition to IFRS However, the ‘relevant accounts’ referred to in company legislation are now IFRS-based accounts Company law accounting rules generally state that only realised profits may be included in the SPLOCI of company legislation accounts; IFRS, however, permits unrealised gains to be included in the SPLOCI of IFRS accounts in certain circumstances Regardless, the profits available for distribution comprise only realised profits less losses

3. Connolly – International Financial Accounting and Reporting – 4 th Edition 18.2 DISTRIBUTIONS A distribution is defined as any distribution of a company’s assets to members (shareholders) of the company, whether in cash or otherwise, with the exception of: an issue of bonus shares; the redemption or purchase of the company’s own shares out of capital (including the proceeds of a new issue) or out of unrealised profits; the reduction of share capital by reducing the liability on shares in respect of share capital not fully paid up and/or paying off paid-up share capital; and a distribution of assets to shareholders in a winding up of the company.

4. Connolly – International Financial Accounting and Reporting – 4 th Edition Distributable profits All companies are prohibited under company legislation from paying dividends except out of profits available for that purpose Distributable profits consist of accumulated realised profits less accumulated realised losses While unrealised profits cannot be distributed, there is no difference between realised profits from normal trading and realised capital profits (e.g. from the sale of a non-current asset) Interim dividends are allowed to be paid, provided they can be justified on the basis of the latest audited financial statements There is a further requirement for Plcs that the total of the net assets of such must be equal to or more than the aggregate of the called-up share capital plus undistributable reserves both at the date of, and immediately after, the distribution Undistributable reserves of a Plc are defined as:  the share premium account;  the capital redemption reserve fund;  the excess of accumulated unrealised profits, not previously capitalised, over accumulated unrealised losses not previously written off by a reduction or reorganisation of capital; and  any other reserve that the company is prohibited from distributing by any enactment, or by its Memorandum of Articles or Association.

5. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 18.1: Distributable profits of public and private companies Calculate the distributable profits of both Companies A and B assuming that each is a: (a) private company; and (a) public company. A LimitedB Limited €000 Share capital1,000 Unrealised profits200 Unrealised losses-200(300)(100) Realised profits300800 Realised losses-300(200)600 Share capital and reserves1,500

6. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 18.1: Distributable profits of public and private companies Solution A Limited: (a) Private Company Realised profits – Realised losses = €300,000 (a) Public Company Net realised profits less Net unrealised losses = €300,000 B Limited: (a)Private Company €800,000 – €200,000 = €600,000 (a)Public Company €600,000 – €100,000 = €500,000

7. Connolly – International Financial Accounting and Reporting – 4 th Edition Distributable profits Companies are allowed to record non-current assets at valuation in the SFP rather than depreciated historical cost (IAS 16 Property, Plant and Equipment – See Chapter 6). If the valuation is higher than the depreciated historical cost, this will lead to a higher depreciation charge in the financial statements and therefore lower profits (relative to historical cost-based financial statements). Consequently, any excess depreciation on a revalued non-current asset above the amount of depreciation that would have been charged on its historical cost can be treated as a realised profit for the purpose of distributions. E XAMPLE 18.2: EXCESS DEPRECIATION ON REVALUED ASSETS Assume a company buys an asset for €20,000, which has a life of four years and a nil residual value. If it is immediately revalued to €30,000, an unrealised profit of €10,000 would be credited to the revaluation reserve. Annual depreciation must be based on the revalued amount, in this case, 25% of €30,000 or €7,500. This exceeds depreciation, which would have been charged on the asset’s cost (€5,000 p.a.) by €2,500 per annum. This €2,500 can be treated as a distributable profit.

8. Connolly – International Financial Accounting and Reporting – 4 th Edition Realised and Unrealised Profits and Losses Company legislation typically does not specifically define realised profits or unrealised profits; instead it states that any determination of whether a profit or loss is realised must be made in light of best accounting practice. The following are the rules contained in company legislation with respect to determining whether a profit or loss is realised or unrealised:  a provision made in the accounts is a realised loss  a revaluation surplus is an unrealised profit  the difference between the depreciation charge based on the revalued amount and the depreciation charge based on the book cost should be regarded as a realised profit  on the disposal of a revalued asset, any unrealised surplus or loss on valuation immediately becomes realised  if there is no available record of the original cost of an asset, its cost may be taken as the value put on it in the earliest available record  if it is impossible to establish whether a profit or loss brought forward was realised or unrealised, any such profit may be treated as realised and any such loss as unrealised

9. Connolly – International Financial Accounting and Reporting – 4 th Edition Revaluation deficits A provision made in the accounts is a realised loss. Therefore, a revaluation deficit is a realised loss. However, if a revaluation deficit arises on a revaluation of all non-current assets (or on a revaluation of all non-current assets other than goodwill), the revaluation deficit is an unrealised loss. Where a company undertakes a partial revaluation of non-current assets, a deficit on one asset is a realised loss and cannot therefore be offset against a surplus on another asset (an unrealised profit) for the purposes of arriving at distributable profits. A partial remedy to this problem is contained in company legislation. This is illustrated in Example 18.3. Deficits arising on an asset where there has been a partial revaluation of the assets are to be treated as unrealised losses provided that:  the directors have ‘considered’ the aggregate value of the non-current assets which have not been revalued at the date of the partial revaluation;  the directors are satisfied that the aggregate value is not less than their aggregate book value; and  a note to the accounts states the above two facts.

10. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 18.3: Revaluation of assets X Limited has the following statement of financial position: €000 Net Assets300 Share capital100 Share premium50 Revaluation reserve70 Retained earnings 80 300 Two of the company’s assets were revalued during the year, one giving rise to a surplus of €100,000, the other a deficit of €30,000. Requirement What are the profits available for distribution and how would the figure differ if all the company’s assets had been revalued?

11. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 18.3: Revaluation of assets Solution Profits available for distribution: €’000 Retained earnings80 Less realised losses (revaluation deficit)(30) 50 If all the company’s assets had been revalued (or the directors had ‘considered’ the value of the assets not revalued), the revalued deficit would be unrealised and therefore the profits available for distribution would be €80,000.

12. Connolly – International Financial Accounting and Reporting – 4 th Edition Revaluation surpluses and Development expenditure Revaluation Surpluses Revaluation surpluses are unrealised profits in the accounting period in which the revaluation takes place and therefore not available for distribution. The only exception to this rule is where the same asset was:  previously revalued giving rise to a deficit; and  the deficit was treated as a realised loss. In such a case, the revaluation surplus will be a realised profit to the extent that it makes good the realised loss. Revaluation surpluses can eventually become realised profits when the asset is either depreciated or sold. Development Expenditure Deferred development expenditure is treated as an unrealised loss if the expenditure is carried forward under the provision of IAS 38 Intangible Assets (see Chapter 9).