Worked Solution
✓ VerifiedVerification of Dividend Declaration Compliance — ABC Ltd. (FY 2024-25)
Applicable Law: Section 123 of the Companies Act, 2013 read with Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 governs the permissible sources and conditions for dividend declaration.
Permissible Sources of Dividend [Section 123(1)]:
A company may declare dividend out of: (i) profits for the current year after providing for depreciation as per Schedule II; (ii) undistributed profits of any previous year(s) after providing for depreciation; or (iii) both. Revaluation reserves and unrealised gains cannot be treated as profits for this purpose.
Step 1 — Verification of Depreciation Provision:
ABC Ltd. has provided ₹1,200 lakhs as depreciation in accordance with Schedule II of the Companies Act, 2013. This is a mandatory pre-condition before appropriating profits for dividend. The condition is satisfied.
Step 2 — Computation of Distributable Profit (Current Year):
Profit After Tax (PAT) for FY 2024-25 = ₹1,350 lakhs. This amount is arrived at after full provision for depreciation (₹1,200 lakhs) and tax (₹450 lakhs), and represents legally distributable current year profit.
Step 3 — Transfer to Reserves:
Under the Companies Act, 2013, there is no mandatory requirement to transfer any fixed percentage of profits to reserves before declaring dividend (the mandatory 10% transfer under the erstwhile Companies Act, 1956 was abolished). The Board may voluntarily transfer to reserves, but it is not a precondition. Accordingly, no deduction is required from PAT on this account.
Step 4 — Total Sources Available for Dividend:
Current year PAT: ₹1,350 lakhs; Accumulated retained earnings: ₹2,000 lakhs; Free reserves (excluding revaluation): ₹500 lakhs. Total available pool = ₹3,850 lakhs.
Step 5 — Proposed Dividend Amount:
Dividend declared = ₹3 per share on face value of ₹10 (i.e., 30% on face value). Total payout = 100 lakh shares × ₹3 = ₹300 lakhs.
Step 6 — Coverage Check:
Proposed dividend (₹300 lakhs) is well within the current year PAT alone (₹1,350 lakhs). There is no need to draw from free reserves or accumulated profits. The proposed dividend represents approximately 22.2% of current year PAT — a conservative payout.
Step 7 — Applicability of Proviso to Section 123(1):
The proviso requires that if the company had incurred a loss in any previous year(s), the amount of loss or depreciation for that year (whichever is less) must be set off against current year profits before declaring dividend. Since ABC Ltd. has substantial accumulated retained earnings of ₹2,000 lakhs, there is no prior year loss. This proviso is not triggered.
Step 8 — Other Mandatory Conditions under Section 123:
(i) Separate Bank Account [Section 123(4)]: The dividend amount of ₹300 lakhs must be deposited in a scheduled bank in a separate account within 5 days from the date of declaration. (ii) Payment Timeline [Section 123(5)]: Dividend must be paid to shareholders within 30 days of declaration. Failure attracts interest at 18% p.a. (iii) No dividend on shares carrying arrears of calls-in-arrears — shares on which any call money is unpaid cannot receive dividend unless articles provide otherwise.
Conclusion: The proposed dividend of ₹3 per share (₹300 lakhs total) is in full compliance with Section 123 of the Companies Act, 2013. Depreciation has been duly provided per Schedule II, current year profits are sufficient to cover the entire payout without resorting to reserves, no mandatory reserve transfer is required, and no prior year losses exist. Subject to procedural compliance (separate bank account within 5 days, payment within 30 days), the dividend declaration is legally valid.
Write it like this
1The skeleton
- Open with the legal anchor — write 'Section 123 of the Companies Act, 2013 read with Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014' in line 1; examiners are scanning for this citation before they read anything else.
- Verify depreciation first, then PAT — don't jump straight to the payout math; show that ₹1,200 lakhs depreciation is per Schedule II and call it a 'mandatory pre-condition satisfied', because the examiner rewards sequencing that mirrors the statutory checklist.
- Kill the mandatory reserve transfer myth explicitly — one sentence stating the 10% transfer to reserves under the old 1956 Act is abolished under CA 2013, no mandatory transfer required; this is a direct mark-grabber because it shows you know the law changed.
- Do the coverage check as a ratio, not just subtraction — state proposed dividend (₹300L) vs current year PAT (₹1,350L) and call it ~22% payout; examiners reward a crisp sufficiency statement over a wall of numbers.
- Hit the procedural conditions in bullet form — separate bank account within 5 days [Section 123(4)], payment within 30 days [Section 123(5)], 18% interest on default; these feel like afterthoughts but carry standalone marks in 5-mark questions.
- Close with one-line conclusion using the word 'complies' — 'The proposed dividend of ₹3 per share complies with Section 123 of the Companies Act, 2013'; never leave a compliance question without a verdict or you silently lose the last half-mark.
2Examiner-rewarded phrases
3Common trap
Most students compute the total available pool (PAT + retained earnings + free reserves = ₹3,850L) and present it as the main answer — but the examiner actually wants you to prove current year PAT alone covers the payout, THEN mention reserves as a backup source. Flipping this order makes your answer look like you don't understand the priority hierarchy under Section 123(1), even if your arithmetic is perfect.