Meaning of Dividend

A dividend is a portion of a company's accumulated profits that is distributed to its shareholders. It represents a return on the investment made by the shareholders in the company. When a company earns a profit, it has two primary options: it can either retain the profits for future growth and expansion (known as retained earnings) or it can distribute a part of it to its shareholders in the form of a dividend.

The decision to pay a dividend and the amount of the dividend is a key financial policy decision made by the company's Board of Directors and subsequently approved by the shareholders. Dividends are typically paid in cash but can also be paid in the form of stock (bonus shares).

Distribution of Profits to Shareholders

The term 'dividend' originates from the Latin word "dividendum", which means "a thing to be divided". In the corporate context, it is the share of the company's distributable profits that is allocated to each shareholder. The amount of dividend a shareholder receives is generally proportional to the number of shares they hold.

For shareholders, dividends are a primary source of income from their investment, separate from any capital gains they might realize by selling the shares at a higher price. For the company, a consistent dividend-paying history is often seen as a sign of financial strength and stability, making it more attractive to investors.

Declaration and Payment of Dividend (Section 123-127)

The process of declaring and paying dividends is strictly governed by the Companies Act, 2013, from Section 123 to Section 127, and the Companies (Declaration and Payment of Dividend) Rules, 2014. These provisions are designed to ensure that dividends are paid out of genuine profits, the process is transparent, and the interests of both the company and its shareholders are protected.

Declaration by Members in AGM (Final Dividend)

The dividend declared at the Annual General Meeting (AGM) is known as the Final Dividend. The procedure is as follows:

1. Board Recommends: The Board of Directors first assesses the company's financial performance for the year. After setting aside funds for reserves and future needs, the Board passes a resolution recommending a specific rate of dividend to be paid to the shareholders.
2. Members Declare: This recommendation is then placed before the shareholders at the AGM for their approval. The shareholders, through an ordinary resolution, formally declare the dividend.
3. Important Rule: The members can approve the dividend at the rate recommended by the Board or at a lower rate. They cannot declare a dividend at a rate higher than what the Board has recommended.

Once declared, the dividend becomes a legally enforceable debt owed by the company to its shareholders.

Interim Dividend

An interim dividend is a dividend declared by the Board of Directors between two AGMs, i.e., during the course of a financial year. Key points are:

• It is declared and paid out of the profits of the company for the current financial year.
• The power to declare an interim dividend must be authorized by the company's Articles of Association.
• The Board must ensure that the company has sufficient profits to justify the payment of an interim dividend. If the company incurs a loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, then the rate of interim dividend shall not be higher than the average dividends declared by the company during the immediately preceding three financial years.

Source of Dividends (Section 123)

Section 123 specifies the sources from which a company can pay dividends:

1. From the current year's profits after providing for depreciation.
2. From the undistributed profits of previous financial years (retained earnings) after providing for depreciation.
3. From money provided by the Central or a State Government for dividend payment in pursuance of a guarantee.

Conditions for Declaration:

• Depreciation: Before declaring any dividend, the company must provide for depreciation in accordance with Schedule II of the Act.
• Transfer to Reserves: A company may, before the declaration of any dividend, transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves of the company. This transfer is voluntary and not mandatory.
• No Dividend out of Capital: A dividend can only be paid out of profits. It is illegal to pay dividends out of the company's capital.

Transfer of Unpaid Dividend (Section 124)

The Act has strict rules for handling dividends that have been declared but not paid or claimed by shareholders.

• Unpaid Dividend Account: Where a dividend has been declared but has not been paid or claimed within 30 days from the date of the declaration, the company must, within 7 days from the expiry of the said 30 days, transfer the total amount of unpaid or unclaimed dividend to a special bank account called the "Unpaid Dividend Account".
• Transfer to IEPF: Any money transferred to the Unpaid Dividend Account which remains unpaid or unclaimed for a period of seven years from the date of such transfer shall be transferred by the company to the Investor Education and Protection Fund (IEPF). The corresponding shares on which the dividend was unpaid for seven consecutive years also get transferred to the IEPF.

Penalty for Non-payment (Section 127)

If a company fails to pay a declared dividend within 30 days, it faces severe penalties:

• Liability of Directors: Every director who is knowingly a party to the default shall be punishable with imprisonment for up to two years and a fine of not less than one thousand rupees (₹1,000) for every day the default continues.
• Liability of Company: The company shall be liable to pay simple interest at the rate of 18% per annum for the period during which such default continues.

Dividend on Preference Shares

Preference shareholders hold a special class of shares that carry preferential rights over equity shareholders with respect to the payment of dividend. Their rights are determined by the terms of issue and the company's Articles of Association.

Preferential Right to Dividend

The primary right of preference shareholders is to receive a dividend at a fixed rate (e.g., 8% Preference Shares) before any dividend is paid to the equity shareholders. If the company has profits, it must first pay the dividend to its preference shareholders before it can consider paying anything to its equity shareholders.

Cumulative vs. Non-Cumulative Preference Shares

The right to dividend on preference shares can be of two types:

• Cumulative Preference Shares: If a company fails to pay the dividend on these shares in any given year due to inadequate profits, the unpaid dividend (arrears) gets accumulated. These arrears must be paid in subsequent years whenever the company makes sufficient profits, before any dividend can be paid to equity shareholders. This provides greater security to the preference shareholder.
• Non-Cumulative Preference Shares: If a company does not declare a dividend on these shares in a particular year, the right to that year's dividend is lost forever. It does not accumulate, and the shareholder cannot claim it in future years.

Unless the Articles specify otherwise, preference shares are always presumed to be cumulative.

Maintenance of Books of Accounts (Section 128)

The maintenance of proper books of accounts is a fundamental legal requirement for any company, irrespective of its size or nature. These accounts form the basis for understanding the financial performance and position of the company. The provisions relating to the maintenance of accounts are laid down in Section 128 of the Companies Act, 2013.

Requirement for Every Company

Section 128(1) mandates that every company shall prepare and keep at its registered office "books of account and other relevant books and papers and financial statement for every financial year".

Key Principles of Account Maintenance

The law requires these books to be maintained on two core principles:

1. True and Fair View: The books must give a "true and fair view" of the state of the affairs of the company. This means the accounts should be accurate, free from material misstatements, and should present a realistic picture of the company's financial health.
2. Accrual Basis and Double-Entry System: The books must be kept on an accrual basis and according to the double-entry system of accounting.
   • Accrual Basis: This means transactions are recorded when they occur, regardless of when the cash is actually received or paid. Revenue is recognized when earned, and expenses are recognized when incurred.
   • Double-Entry System: This is the standard system of bookkeeping where every transaction has a dual effect and is recorded with a corresponding debit and credit entry, ensuring that the accounting equation (Assets = Liabilities + Equity) always remains in balance.

Location and Preservation

• Location: The books must be kept at the registered office of the company. The Board may decide to keep them at any other place in India, provided a Board resolution is passed and the company files a notice with the Registrar of Companies (RoC) within 7 days.
• Electronic Mode: The company is permitted to maintain its books of account in electronic mode, provided they are accessible in India, remain complete and unaltered, and are backed up properly.
• Preservation Period: The books of account of every company relating to a period of not less than eight financial years immediately preceding a financial year must be preserved in good order.
• Inspection: The books of account are open to inspection by any director during business hours.

Financial Statements

Financial Statements are the end product of the accounting process. They are a set of formal reports that provide a structured summary of a company's financial performance over a period and its financial position at a specific point in time. They are the primary source of financial information for stakeholders like shareholders, creditors, investors, and government agencies.

The definition of "financial statement" is provided under Section 2(40) of the Companies Act, 2013. It is an inclusive definition and covers several components.

Balance Sheet, Profit and Loss Account, Cash Flow Statement, Statement of Changes in Equity, etc.

According to Section 2(40), a financial statement in relation to a company includes:

1. A Balance Sheet as at the end of the financial year:

   This is a statement of the company's assets, liabilities, and equity at a particular point in time. It provides a snapshot of what the company owns (assets) and what it owes (liabilities). The format of the Balance Sheet is prescribed in Part I of Schedule III to the Act.

2. A Profit and Loss Account, or in the case of a company carrying on activity not for profit, an Income and Expenditure Account for the financial year:

   This statement, also known as the Statement of Profit and Loss, summarises the company's revenues, expenses, gains, and losses over a period, ultimately arriving at the net profit or loss for that period. Its format is prescribed in Part II of Schedule III to the Act.

3. Cash Flow Statement for the financial year:

   This statement shows the movement of cash and cash equivalents into and out of the company. It classifies the cash flows into three activities: Operating, Investing, and Financing. As per the Act, a Cash Flow Statement is mandatory for all companies except a one person company, small company, and dormant company.

4. A Statement of Changes in Equity, if applicable:

   This statement details the changes or movements in the company's shareholders' equity over the financial year. It reconciles the opening and closing balances of equity, showing the impact of transactions like profit/loss for the period, dividends paid, and issue or redemption of share capital.

5. Any Explanatory Note annexed to, or forming part of, any document referred to in sub-clause (i) to sub-clause (iv):

   These notes are an integral part of the financial statements. They provide detailed information and disclosures that cannot be conveniently placed in the body of the main statements, such as the company's accounting policies, contingent liabilities, and further breakdowns of items in the balance sheet and P&L account.

Preparation and Adoption of Financial Statements (Section 134)

The preparation, approval, and presentation of financial statements is a formal and crucial process that ensures accountability of the management to the shareholders. This process is primarily governed by Section 134 of the Companies Act, 2013.

Preparation

The financial statements must be prepared in accordance with the accounting standards notified under Section 133 and must comply with the format laid down in Schedule III of the Act. Above all, they must give a true and fair view of the company's state of affairs.

Approval and Signing

Before the financial statements are presented to the auditors for their report and to the members for their adoption, they must be formally approved by the company's management.

1. Approval by the Board: The financial statements must be approved by the Board of Directors.
2. Signing: After approval, they must be signed on behalf of the Board by at least:
   • The chairperson of the company (if authorised by the Board), or by two directors out of which one shall be the managing director (if there is one).
   • The Chief Executive Officer (if they are a director).
   • The Chief Financial Officer.
   • The Company Secretary.

Board's Report

A detailed Board's Report must be attached to the financial statements laid before the members in a general meeting. This report is the Board's communication to the shareholders about the company's performance, operations, and future outlook. It must include, among other things:

• The state of the company's affairs.
• The amounts proposed to be carried to reserves and declared as dividend.
• Material changes and commitments affecting the financial position of the company.
• A Directors' Responsibility Statement, which confirms that the directors have followed accounting standards, selected prudent accounting policies, taken proper care to maintain records, and prepared the accounts on a going concern basis.

Adoption by Members

The final step is the adoption of the accounts by the members. The Board-approved and audited financial statements, along with the Board's Report and the Auditor's Report, are placed before the members at the Annual General Meeting (AGM). The consideration and adoption of these accounts is one of the four ordinary businesses of every AGM.

Meaning and Purpose of Audit

An audit is a systematic, independent, and documented process of examining a company's financial statements, books of account, and related records to form an opinion on whether they present a "true and fair view" of the company's financial position and performance. It is a critical function that lends credibility to the financial information prepared by the company's management.

The person conducting the audit is known as the auditor. For a company, the statutory audit must be conducted by a qualified Chartered Accountant (or a firm of Chartered Accountants) who is independent of the company.

Independent Examination of Financial Statements

The core of an audit is its independence. The auditor must be free from any influence, interest, or relationship that could impair their professional judgment or objectivity. This independence allows stakeholders—such as shareholders, investors, creditors, and government authorities—to rely on the auditor's report as an unbiased assessment of the financial statements.

Purpose of an Audit

• Lending Credibility: The primary purpose is to enhance the degree of confidence of intended users in the financial statements. An audited statement is considered more reliable than an unaudited one.
• Ensuring Compliance: The auditor verifies whether the financial statements have been prepared in compliance with the relevant legal framework, including the Companies Act, 2013, and the applicable Accounting Standards.
• Detection of Errors and Frauds: While not the primary objective, a properly conducted audit is designed to provide reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. The auditor maintains an attitude of professional skepticism throughout the audit.
• Protecting Stakeholder Interests: By providing an independent opinion, the auditor acts as a guardian of the financial interests of the shareholders and other stakeholders who do not have direct access to the company's records.

Answer:

Appointment of Auditors (Section 139)

The appointment of an independent auditor is a mandatory statutory requirement for every company. The procedure for appointment is laid down in Section 139 of the Companies Act, 2013, and varies for the first auditor and subsequent auditors.

First Auditor

The first auditor is appointed to hold office from the conclusion of their appointment until the conclusion of the first Annual General Meeting (AGM).

In case of a Non-Government Company:

1. The Board of Directors shall appoint the first auditor within 30 days of the date of registration of the company.
2. If the Board fails to appoint, it shall inform the members, who shall then appoint the auditor within 90 days at an Extraordinary General Meeting (EGM).

In case of a Government Company:

1. The Comptroller and Auditor-General of India (C&AG) shall appoint the first auditor within 60 days from the date of registration.
2. If the C&AG fails to appoint, the Board of Directors shall appoint the auditor within the next 30 days.
3. If the Board also fails, it shall inform the members, who shall appoint the auditor within the next 60 days at an EGM.

Subsequent or Statutory Auditor

Every company shall, at its first AGM, appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting until the conclusion of its sixth AGM. This means the auditor is appointed for a term of five years.

The company must place the matter relating to such appointment for ratification by members at every subsequent AGM. The company is also required to inform the auditor of their appointment and file a notice of such appointment with the Registrar of Companies (RoC) in Form ADT-1 within 15 days of the meeting.

Rotation of Auditors

To ensure independence and prevent long-term associations from impairing objectivity, Section 139(2) mandates the rotation of auditors for certain classes of companies. This applies to all listed companies and certain other public and private companies. The rules are:

• An individual auditor cannot be appointed for more than one term of five consecutive years.
• An audit firm cannot be appointed for more than two terms of five consecutive years each.

After completing their term, the individual or firm is subject to a "cooling-off" period of five years before they can be re-appointed.

Removal of Auditors (Section 140)

The process for removing an auditor before the expiry of their term is deliberately difficult to protect the auditor's independence. An auditor can be removed only for valid reasons and by following a strict procedure:

1. The Board passes a resolution to remove the auditor.
2. The company files an application with the Central Government (power delegated to Regional Director) in Form ADT-2 within 30 days of the Board resolution, seeking its approval.
3. After receiving the Central Government's approval, the company holds a general meeting within 60 days.
4. A Special Resolution (requiring a 75% majority) is passed by the members to remove the auditor.

The auditor concerned must be given a reasonable opportunity of being heard before the removal.

Rights, Duties, and Liabilities of Auditors (Section 143)

The Companies Act, 2013, grants auditors certain rights to enable them to perform their duties effectively and also imposes duties and liabilities to ensure they act with due care and diligence.

Rights (Powers) of an Auditor

• Right of Access to Books: The auditor has a right to access the books of account and vouchers of the company at all times, whether kept at the registered office or elsewhere.
• Right to Obtain Information: The auditor is entitled to require from the officers of the company such information and explanations as they may think necessary for the performance of their duties.
• Right to Attend General Meetings: The auditor has the right to receive notices of and attend any general meeting of the company. They also have the right to be heard at such meetings on any part of the business that concerns them as an auditor.
• Right to Lien: An auditor has the right to retain the client's books and documents in their possession if their fees have not been paid.

Duties of an Auditor

• Duty to Inquire: The auditor has a duty to inquire into specific matters, such as whether loans and advances have been properly secured, whether transactions are prejudicial to the company's interests, and whether personal expenses have been charged to the revenue account.
• Duty to Report: The primary duty is to make a report to the members on the accounts examined by them. The report must state whether, in their opinion, the financial statements give a true and fair view.
• Duty to Report Fraud (Section 143(12)): This is a critical duty. If an auditor, in the course of their audit, has reason to believe that a fraud involving an amount of one crore rupees or more has been committed against the company by its officers or employees, they must report the matter to the Central Government. For frauds involving lesser amounts, the matter must be reported to the Audit Committee or the Board.
• Duty to Comply with Auditing Standards: The auditor must conduct the audit in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India (ICAI).

Liabilities of an Auditor

An auditor can be held liable for failing to perform their duties with reasonable care and skill.

• Civil Liability: This arises from negligence. If an auditor is negligent and the company or a third party suffers a loss as a result, a suit for damages can be filed against the auditor.
• Criminal Liability: This arises from more serious offences. An auditor can be held criminally liable if they willfully make a false statement in any report or document. For instance, under Section 447 of the Act, if an auditor is found to be involved in fraud, they can face imprisonment for up to 10 years and a substantial fine.

Audit Report

The Audit Report is the final product of the audit process. It is the formal document in which the auditor expresses their opinion on the truth and fairness of the company's financial statements. It is addressed to the members of the company and is a key component of the company's Annual Report.

Types of Audit Opinions

The auditor's opinion is the cornerstone of the report. It can be of the following types:

1. Unmodified Opinion (or Clean Report): This is the best possible outcome. The auditor issues an unmodified opinion when they conclude that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework and give a "true and fair view".
2. Modified Opinion: If the auditor has reservations, they issue a modified opinion. This can be of three types:
   • Qualified Opinion: This is issued when the auditor concludes that misstatements, individually or in aggregate, are material but not pervasive to the financial statements. The report essentially states that the financial statements are true and fair "except for" the effects of the matter to which the qualification relates.
   • Adverse Opinion: This is the most severe type of modified opinion. It is issued when the auditor concludes that the misstatements are so material and pervasive that the financial statements as a whole do not present a true and fair view.
   • Disclaimer of Opinion: This is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion. This could be due to a significant limitation on the scope of the audit. The auditor does not express an opinion in this case.

Contents of the Audit Report

The format and contents of the audit report are governed by the Standards on Auditing. A typical report includes:

• Title and Addressee: Clearly identifying it as an 'Independent Auditor's Report' and addressed to the members of the company.
• Auditor's Opinion: The section containing the auditor's conclusion.
• Basis for Opinion: A section that provides context to the opinion, stating that the audit was conducted in accordance with the Standards on Auditing.
• Key Audit Matters (KAM): For listed entities, this section highlights the most significant matters in the audit of the current period's financial statements.
• Responsibilities of Management and the Auditor: Sections detailing the respective responsibilities of the management (for preparing the financial statements) and the auditor (for expressing an opinion on them).
• Report on Other Legal and Regulatory Requirements: The auditor also reports on matters required by the Companies Act, such as whether the company has an adequate internal financial controls system in place.