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DIVIDEND, ACCOUNT AND AUDIT[1]

Table of Contents

QUESTION BANK

Q.1 “Auditor is a watch dog, but not blood hound”, Discuss.

Q.2 Define duties and powers of Auditor, Remuneration of Auditor.

Q.3. “Dividend is paid out of profit, not from capital” Discuss critically.

Q.4. Define dividend and debentures. Elaborate the kinds of dividends and debentures.

SHORT NOTES

Q.1 Auditor.

Q.2 Dividend

Q.3 Accounts.

I] DIVIDENDS (S. 123 to 127):-

A dividend is a distributive share of a company’s profit given to its shareholders. In other words, a dividend is a profit divided amongst the company members based on their shares.

Every company is formed to earn profit. The profit earned by the company is divided amongst its shareholders through a dividend, which is always paid out of the company’s profits.

Every company has the inherent power to distribute its profits to its shareholders through a dividend. No express provision in the memorandum or article of association is necessary to distribute profit through dividends.

A) Declaration of Dividend (S. 123):-

A dividend can only be declared by shareholders in a general meeting. However, such amount of dividend should not exceed the amount recommended by the Board of Directors[2]. In other words, directors can only recommend the amount of dividend to the general meeting of shareholders; however, shareholders cannot declare more than the Board recommended.

1) Interim Dividend[3] (S. 123 (3)):-

In addition to the above dividend, a company, by an article of association, may empower directors to declare an interim dividend. An ‘interim dividend’ is a dividend the directors declare between two annual general meetings. However, before declaring such an interim dividend, the Board shall confirm the company’s sound financial position. S. 123 (3) provides that the Board of Directors of a company may declare an interim dividend during any financial year out of the surplus in the profit and loss account and out of profits of the financial year in which such interim dividend is sought to be declared.

In case the company has incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of the interim dividend, such interim dividend shall not be declared at a rate higher than the average dividend declared by the company during the immediately preceding three financial years.

2) Dividend is to be paid only out of Profit (S. 123 (1)):-

Dividends can always be paid out of profit and not from a company’s capital[4]. S. 123 (1) provides that the dividend will be paid from the following three sources, viz.

(i) the profits of the company from that financial year for which the dividend is to be paid.

(ii) undistributed profits of the previous financial years;

(iii) money provided by the Central or State Government for the payment of dividends in pursuance of a guarantee by that government.

However, the profit is to be arrived at after providing (deducting) depreciation. The depreciation shall be provided in accordance with the provisions of Schedule II.

Generally, directors decide on dividends and suggest them at the general meeting.

3) Transfer to Reserves:-

A company may, before the declaration of any dividend, transfer such a percentage of its profits for that financial year as it may consider appropriate. The Board of Directors is free to decide the percentage of profit transferred to reserves before declaring a dividend.

4) Declaration of dividend out of accumulated profits:-

In case of inadequacy or absence of profits in any financial year, if the company proposes to declare a dividend out of the accumulated profits earned in previous years and transfer to the reserves, such declaration of dividend shall not be made except in accordance with such rules as may be prescribed in this behalf.

No dividend shall be declared or paid by a company from its reserves other than free reserves. According to S. 2 (43), a free reserve means “such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend…”. However, as per the definition, the following shall not be treated as a free reserve, viz.-

Any amount representing unrealised gains[5], notional gains[6] or revaluation of assets[7], whether shown as a reserve or otherwise, or
Any change in the carrying amount of an asset or liability recognised inequity,

surplus in profit and loss accounts for the measurement of the asset or the liability at fair value.

5) Time and manner of Deposit of dividend:-

The amount of the dividend, including the interim dividend, shall be deposited in a scheduled bank in a separate account within five days from the date of declaration of the dividend.

6) A declared dividend is a debt[8]:-

When a dividend is declared in a general meeting of shareholders, it becomes a statutory debt. Shareholders can even recover it by filing suit. After the dividend is declared in the general meeting, the company becomes a trustee of that amount and cannot use that fund for any other purpose.

7) To whom the Dividend shall be paid:-

No dividend shall be paid by a company with respect to any share therein except to the registered shareholder of such share or his order or to his banker, and it shall be payable except in cash. In other words, the dividend shall not be paid in kind. However, capitalisation of profits or reserves of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount is permissible.

8) Mode of payment of dividend:-

Any dividend payable in cash may be paid by cheque, warrant, or electronic mode to the shareholder entitled to the payment of the dividend.

9) Prohibition on payment of dividends:-

If a company violates the provisions of Ss. 73 and 74 (relating to accepting deposits from the public and their repayment), it shall not declare any dividend on its equity shares until non-compliance (non-payment) exists.

B) Transfer of Unpaid dividends (S. 124):-

Where a company has declared a dividend-

but has not been paid or claimed within thirty days from the date of the declaration to any shareholder entitled to the payment of the dividend,
the company shall, within seven days from the date of expiry of the said period of thirty days,

(iii) transfer the total amount of dividend which remains unpaid or unclaimed to a special account, to be opened by the company on that behalf, in any scheduled bank, to be called the “Unpaid Dividend Account”.

The company shall, within a period of ninety days of making any transfer to the Unpaid Dividend Account, prepare a statement containing the names, their last known address, and the unpaid dividend to be paid to each person and place it on the website of the company, and also on any other website approved by the Central Government for this purpose, in such form, manner and other particulars as may be prescribed.

Suppose any default is made when transferring the total amount as referred to above or any part thereof. In that case, the company shall pay from the date of such default interest on so much of the amount as has not been transferred to the said account at the rate of twelve per cent per annum. The interest accruing on such an amount shall ensure the benefit of the company’s members in proportion to the amount remaining unpaid to them.

Any person claiming to be entitled to any money transferred to the Unpaid Dividend Account may apply to the company to pay the money claimed.

Suppose the money transferred to the Unpaid Dividend Account remains unpaid or unclaimed for a period of seven years. In that case, it shall be transferred, along with interest accrued thereon, to the “Investor Education and Protection Fund” established by the Central Government for the education and protection of investors.

Suppose the company fails to comply with the provisions of this section. In that case, the company shall be punishable with a fine which shall not be less than one lakh rupees but which may extend to twenty lakh rupees. Every officer of the company who is in default shall be punishable with a fine which shall not be less than twenty-five thousand rupees but which may extend to two lakh rupees. The company shall also be liable for a further penalty of Rs. 500 for each day of further continuance of failure and an officer for rupees 100 per day.

C) Punishment for failure (S. 127):-

Where dividend has been declared but not paid, or the warrant in respect thereof has not been posted within thirty days from the date of declaration, every director who is knowingly a party to the default shall be punishable with imprisonment up to 2 years and with a fine of rupees one thousand for every day during which the default continues. The company shall be liable to pay simple interest at the rate of Rs. 18 % per annum.

However, no punishment is imposed if the default in payment is due to the operation of any law, a dispute about the claim, etc.

II] ACCOUNTS (S. 128 to 137):-

A) As to books of account:-

1) Duty to keep books of account (S. 128):-

The Act does not mention the names of the books of account to be kept by the company. However, it provides that the company must keep proper books of account that will give a true and fair view of the company’s state of affairs and its various transactions.

2 (13) lists the matters relating to which books of accounts are to be kept. Books of Account include records maintained in respect of-

(a) all sums of money received and expended by the company and the matters related to such receipt and expenses.

(b) all sales and purchases of goods and services by the company.

(d) in case the company is engaged in production, processing or mining activities particulars related to the utilisation of material or labour or other items of cost.

Provided further that the company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed.

2) The period for which books of accounts are to be kept:-

Books of accounts of the last eight years immediately preceding the current year and vouchers shall be preserved in good condition. However, where the company has existed for less than eight years, the books of account for all the preceding years are to be kept. It is further provided that where an investigation is ordered concerning the company, the Central Government may direct that the books of account be kept for such a longer period as it may deem fit.

3) Books of account to be kept at the registered office:-

Every company shall keep its books of account at its registered office or such other place in India as the Board of Directors may decide. If a company has a branch office in or outside India, it shall maintain proper books of account of that branch.

4) Custody of books of Account:-

The Custody of the books of account is given to the managing director, the whole-time director, the Chief Financial Officer, or any other person of a company charged by the Board.

5) Right of Inspection of books of accounts:-

The books of account and other papers are open for inspection during business hours-

(i) by any director,

(ii) by the Registrar, and

(iii) by any officer of the government authorised by the Central Government.

There is no need for previous notice to the company or any officer for such an inspection. The right of inspection includes the right to get extracts. It is the director’s personal right, and he cannot delegate it to anybody else.

6) Punishment for contravention:-

If the person in charge of keeping books of account contravenes provisions of this section, he shall be punishable with a fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees.[9].

B) Laying financial statements before the annual general meeting (S. 129 (3) and (4)):-

The company’s Board of Directors presents financial statements for each financial year at its annual general meeting.

Where a company has one or more subsidiaries, it shall also prepare consolidated financial statements for the company and of all the subsidiaries in the same form and manner as its own.

The rules applicable to the preparation, adoption, and audit of a holding company’s financial statements shall, with necessary changes, also apply to the subsidiary company’s consolidated financial statements.

After laying the balance sheet and profit and loss account before the annual general meeting, the same may be filed to the Registrar of Companies within 30 days. If, for any reason, the annual general meeting is not held in any year, the above documents are to be filed with the Registrar within 30 days from the date on which the annual general meeting ought to have been held (S. 137).

The members can get copies of audited financial statements and other relevant documents (S. 136).

C) Other provisions relating to accounts:-

The accounts can be reopened upon the court’s or Tribunal’s order (S.130). Moreover, the director may voluntarily revise financial statements or the Board’s report (S. 131). The Central Government may, by notification, constitute a National Financial Reporting Authority to provide for matters relating to accounting and auditing standards under this Act (S. 132). The Central Government is empowered to prescribe accounting standards (S. 133).

III] AUDIT (Ss. 139 to 148):-

Auditing companies’ accounts is a very important process to safeguard the company’s interests. The auditor is appointed by the shareholders in the annual general meeting to protect their interests. It is the foremost and most important protection available to the shareholders. The auditor is the servant of shareholders, and it is his duty to examine the company’s accounts and report to shareholders on its true affairs.

A) Appointment of auditors (S. 139):-

At the first annual general meeting, every company shall appoint an individual or a firm as auditors who shall hold office from the conclusion of that meeting until the conclusion of its sixth annual general meeting and thereafter until the conclusion of every sixth meeting. The manner and procedure of selection of auditors by the company members at such meeting shall be as prescribed.

1) Appointment of the first Auditor:-

The board of directors shall appoint the first auditor of a company (other than a government company) within thirty days of the registration date. If the Board fails to appoint such an auditor, it shall inform the company’s members, who shall appoint such an auditor within ninety days at an extraordinary general meeting. Such an auditor shall hold office until the conclusion of the first annual general meeting.

2) Rectification of appointment at every annual general meeting:-

The company shall place the matter relating to such appointment for ratification by members at every annual general meeting.

3) Compliance before appointment:-

Before the appointment, the company shall obtain from the auditor-

The auditor’s written consent is required for such an
Certificate that-
The auditor is eligible for an appointment and is not disqualified for an appointment under the law.
The proposed appointment is in accordance with the terms provided under the Companies Act.

4) Compliance after appointment:-

The company shall inform the auditor concerned of his or her appointment and also file a notice of such appointment with the Registrar within fifteen days of the meeting in which the auditor is appointed.

5) Mandatory Rotation of Auditors:-

A listed company and the company belonging to such class as may be prescribed by the Central Government shall not appoint or reappoint-

An individual as an auditor for more than one term of five consecutive years.
An audit firm for more than two terms of five consecutive years.

6) No re-appointment for the next five years:-

An individual auditor or a firm of auditors (or the firms having a common partner) who has completed his/her term as discussed above shall not be eligible for re-appointment in the same company for the next five years from the completion of his/her term.

In other words, the auditor or the firm of auditors or (the firm having a common partner) who has completed his/its term of auditing is not eligible for appointment for the next five years; however, after the period of five years, the auditor or the firm can be reappointed.

7) Casual vacancy:-

The Board of Directors is to fill a casual vacancy caused by the auditor’s resignation within 30 days, but the company should approve the appointment at a general meeting convened within three months of the board’s recommendation. Then, he shall hold the office until the conclusion of the next annual general meeting.

However, suppose a casual vacancy occurs in the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor General of India. In that case, the vacancy is to be filled by the Comptroller and Auditor General of India within thirty days. However, if the Comptroller and Auditor General of India fail to fill the vacancy, the Board of Directors shall fill the vacancy within the next thirty days.

B) Removal, Resignation of auditor and giving of special notice (S. 140):-

The auditor appointed may be removed from his office before the expiry of his term only by special resolution of the company after obtaining the previous approval of the Central Government. However, before taking any action, the auditor concerned shall be given a reasonable opportunity to be heard.

The auditor who has resigned from the company shall file a statement in the prescribed form with the company within thirty days from the date of resignation.

C) Eligibility, qualification and disqualification of auditor (S. 141):-

a) Qualification:-

Qualification of an individual-

A person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant.

Qualification for a firm-

A firm whereof majority of partners practising in India are qualified for appointment as aforesaid may be appointed by its firm name to be the auditor of a company.

b) Disqualification:-

The following are disqualified from the company auditor:

(i) A body corporate, i.e. company, other than a limited liability partnership registered under the Limited Liability Partnership Act, 2008.

(ii) an officer or employee of the company,

(iii) a partner or employee of an officer or employee of a company, or

(iv) a person who or his relative or partner-

is holding any security of, or interest in the company or the subsidiary, or of its holding or associate company or a subsidiary of such a holding company. The relative may hold security or interest in the company of sale value not exceeding one thousand rupees or such sum as may be prescribed.
Is indebted to the company or its subsidiary or its holding or associated company or a subsidiary of such a holding company in excess of such amount as may be prescribed.
Has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, its subsidiary or its holding company for such amount as may be prescribed.

(v) a person or a firm who, directly or indirectly, has a business relationship with the company, its subsidiary, its holding company, or associate company of such nature as may be prescribed.

(vi) a person whose relative is a director or is employed by the company as a director or key managerial personnel.

(vii) a person who is in full-time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or re-appointment holding appointment as auditor of more than twenty companies.

(viii) a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction.

(ix) any person whose subsidiary or associate company or any other form of entity is engaged, as on the date of appointment, in consulting and specialised services as prohibited under S. 144.

D) Powers and Duties of an auditor (S. 143):-

a) Powers of auditor:-

The auditor has the following powers-

1) Right of access to the books of account and vouchers:-

Every company auditor shall have a right of access at all times to the company’s books of account and vouchers, whether kept at the company’s registered office or at any other place.

2) Right to get information:-

The auditor shall be entitled to require, from the company’s officers or its subsidiary, such information and explanation as he may consider necessary for performing his duties as an auditor.

3) Right to inquire:-

Auditors, among other matters, can inquire into-

Whether loans and advances made by the company are properly secured?
Whether transactions of the company are prejudicial to the interests of the company?
Whether the company’s assets have been sold at a price less than that they were purchased?
Whether loans and advances made by the company are shown as deposits?
Whether personal expenses are charged to the revenue account?
Whether shares shown as sold on cash in account books are actually sold for cash?

(g) Whether facts mentioned in account books correct?

b) Duties of Auditor:-

An auditor has the following duties-

1) Make Report:-

The auditor has to report to the company’s members, on the accounts examined by him and on every financial statement which is required to be laid in the company’s general meeting. The Audit report should state that, to the best of his information and knowledge, the accounts and financial statements give a true and fair view of the state of the company’s affairs, the profit or loss, the cash flow for the year and such other matters as may be prescribed. The auditor’s report shall also state other details such as:-

(a) Whether he has sought and obtained all the necessary information and explanations and, if not, the details thereof and the effect of such information on the financial statements.

(b) Whether, in his opinion, proper books of account as required by law have been kept by the company, and proper returns adequate for the purposes of his audit have been received from branches not visited by him.

(d) Whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns.

(e) Whether, in his opinion, the financial statements comply with the accounting standards.

(f) The auditors’ observations or comments on financial transactions or matters that adversely affect the functioning of the company.

(g) Whether any director is disqualified from being appointed as a director under section (164 (2) (h)). Any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith.

(i) Whether the company has an adequate internal financial controls system in place and the operating effectiveness of such controls.

2) Comply with Auditing Standards:-

Every auditor shall comply with the auditing standards. Meanwhile, the central government prescribes the auditing standards or addendums thereto.

3) Reporting of fraud:-

Suppose an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company. In that case, he shall immediately report the matter to the Central Government within 60 days of his knowledge.

The auditor is required to exercise reasonable care and skill in certifying and verifying the company’s accounts and properly reporting on them.

A very famous dictum, which explains auditors’ position and duty, is uttered in the English Case Re Kingston Cotton Mills Company.[10] that “an auditor is not bound to be a detective or approach his work with a foregone conclusion that something is wrong. He is a watchdog but not a bloodhound. He is justified in believing tried servants of the company in whom confidence is placed by the company”.

In other words, his duty is to act as a watchdog (auditing the account carefully) and bark if there is any suspicious act and wake up its masters (i.e. shareholders) on that point, but not to act as a bloodhound (i.e., act suspiciously and take action against trusted company’s men).

4) At the time of Winding Up (S. 305):-

At the time of a company’s voluntary winding up, the auditor must attach a copy of the company audit he prepared.

5) Duty not to render certain services (S. 144):-

To maintain his impartiality, the auditor shall provide only such other services approved by the Board of Directors or the audit committee to the company. However, the following services shall not be provided, viz.-

Accounting and bookkeeping services.
Internal audit.
Design and implementation of any financial information system;
Actuarial services.
Investment advisory services.
Investment banking services.
Rendering of outsourced financial services.
Management services.
Any other kind of services may be prohibited.

6) Duty to sign audit reports, etc. (S. 145):-

The auditor of a company shall sign the auditor’s report or sign or certify any other prescribed document.

7) To attend the general meeting (S. 146):-

The auditor shall, unless exempted, attend either himself or through his authorised representative at any general meeting.

8) Other Duties:-

Besides the above duties, there are other duties of an auditor to be performed in the course of his audit, such as

a) The auditor should provide all possible assistance to the inspectors if they investigate the company’s affairs.
b) In case an existing company issues a prospectus, it should contain a statement of profit and losses for the last 5 years showing the rate of dividends paid on each class of shares for each year and a statement of assets and liabilities of the company. It is the duty of the auditor to certify all these statements.

E) Punishment for contravention (S. 147):-

If any of the provisions of Ss. 139 to 148 is contravened, the company shall be punishable with a fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, and every officer of the company who is in default shall be punishable with a fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees.

Suppose the auditor of a company contravenes any of the provisions under S. 139, 143, 144 or 145. In that case, he shall be punishable with a fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees or four times the remuneration of the auditor, whichever is less[11]. However, if the auditor contravenes such provisions knowingly or willfully with the intention to deceive the company, its shareholders, creditors, or tax authorities, he shall be punishable with imprisonment for a term that may extend to one year and with a fine that shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees or eight times the remuneration of the auditor, whichever is less.

F) Removal, Resignation of auditor (S. 140):-

The auditor appointed may be removed from his office before the expiry of his term only by a special resolution of the company after obtaining the previous approval of the Central Government on that behalf in the prescribed manner. However, before taking any action against him, the auditor shall be given a reasonable opportunity to be heard.

Audit of cost accounts (S. 148):-

Cost accounts pertain to production, processing, manufacturing, or mining companies. These companies are required to keep proper books of account with particulars relating to the utilization of material, labour, or other costs.

The Central Government may, by order, direct that an auditor who is a cost accountant conduct an audit of the company’s cost accounts whenever necessary.

The Board of Directors shall appoint the auditor with the previous approval of the Central Government. Such cost audit is in addition to normal audit.

*****

[1] लाभांष, हिषोब व हिषोब तपासणाी [लाभांश खाता और लेखापरीक्षा]

[2] Table 85

[3] दरम्यानचा लाभांश [अंतरिम लाभांश]

[4] K. Madhava V. Popular Bank (1969) 39 Comp Case 717 and Re-Exchange Banking Corporation (1882) 21 Ch. D. 519

[5] न मिळालेले उत्पन्न [अप्राप्त लाभ]

[6] काल्पनीक उत्पन्न [काल्पनिक लाभ]

[7] मिळकतीची पुर्णर किंम्मत निश्चीती [संपत्ति का पुनर्मूल्यांकन]

[8] घोशीत लाभांष हा कंपणीवर कर्ज समजण्यात येतो [घोषित लाभांश एक ऋण है]

[9] Punishment is reduced by 2020 amendment.

[10] (1896) 2 Ch 279 (C.A).

[11] Inserted by 2018 amendment.