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Hi Mike,
I came across this statement in and don’t fully understand it:
Plcs can only declare dividend if net assets will not fall below total of called up share capital and undistributable reserves
Could you help explain it in simple terms?
Does it mean that net assets (total assets – total liabilities) have to be greater than share capital called up (I think this is allotted SC less any liabilities on partly paid shares) plus undistributable reserves (share premium, revaluation surplus, etc). So this figure would always be greater unless the business has been making losses? I think I’ve just confused myself further trying to figure it out…
You’re absolutely correct! Where a company has an Accumulated Deficit in Distributable Reserves ( normally just the Profit or Loss Account but also including such reserves as a General Reserve) then it is illegal for that company to declare / pay a dividend where, as a result of that dividend, net assets would fall below the subtotal of Share Capital + Undistributable Reserves
Imagine we have Share Capital 100, Share Premium 20, subtotal 120, General Reserve 30, Profit or Loss Account (10) and a total of $140
TNCA of 100, CA of 60 and CL of 20 with a total of $140
And we would like to pay a dividend of 25 financed by the General Reserve ie Debit General Reserve and Credit Cash 25 General Reserve goes down to 5 and CA goes down to 35
Share Capital still 100, Share Premium still 20, subtotal still 120 General Reserve is now 5 and profit or Loss Account is still (10) with a total of $115
TNCA still 100, CA is now 35, subtotal 135, CL 20, total net assets $115
BUT!!! Net Assets of $115 is now lower than the subtotal of Share Capital + Undistributable Reserves $120
And that’s not allowed!
OK?
Thanks Mike, your explanation makes it really clear. I think I was half way there but now fully understand it.
Cheers,
Thomas
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