Audit and Accounts
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This article has been written by Avni Sharma, a 2nd year student intern from National Law University Odisha. The article talks about Dividends, Audit and Accounts and the legal provisions pertaining to the same.

Every company in the market requires maintenance of Dividends, Audits, and Accounts as these form the basis of the financial planning of the company. This article talks about the foundational concepts given under the Companies Act, 2013 (the Act). Dividends are provided under Section 2(35) of the Act and Audits are mentioned under Section 224 of the Act.

In this article, we will have a look at meanings, legal aspects, and case laws in relation to Dividends, Audits and Accounts.

Dividends

The word ‘Dividend’ finds its origin in the Latin term “dividendum” which means ‘to divide’. When a company borrows money from the shareholders, it naturally shares its profits. This share of profit is known as a dividend. Notably, dividends do not form a part of the rights of shareholders but only when the dividends are declared by the company, the right to claim the dividends arise. 

Dividend fund

We will now move forward to understand other terms related to dividends. Dividend fund is the amount of cash which is to be distributed as dividends. In some places, it also refers to the maximum amount of cash which may be paid out as dividends.

In Lubbock v. British Bank of South America, it was held that all the receipts of the company, other than those related to the issue of shares to its shareholders will be combined positively in the calculation of the total amount of dividend fund.

Statutory provisions

The statutory provisions are mentioned in the Companies Act, 2013. The Act has always been dynamic in nature and has been amended whenever the lawmakers felt a need to set the norms according to the present requirements. The major amendment came in 2013 when the Companies Act, 1956 was repealed and was replaced with a new Act known as the Companies Act, 2013. The new Act contains standards according to modern times and its requirements.

The following table represents all the imperative legal provisions in relation to dividends:

Sec. of the Companies Act, 2013

Matters Dealt with

Section 51

The section states about payment of dividend in proportion with the amount of each share. 

Section 91 

The companies have the authority to close its register of Members, Debenture holder or any other security holders.

Section 123

(a) The section states the announcement and the declaration of dividends.

 

(b)(5) The dividend shall only be paid to the person himself, or his or her bank, or his or her order.

Section 124

The section states the account to be maintained for Unpaid Dividend.

Section 126

The section lays emphasis on the rights of shareholders to dividend, bonus shares, etc.

Section 127

The section explains the punishment in case of non-payment of dividend.

Separate bank account for dividend

We will have a look at the conditions and requirements for the payment of dividends. The requirements include:

  1. Compliance with Sections 73 and 74 of the Companies Act, 2013.
  2. Grant of a Proportional Dividend.
  3. Deposition of Dividend in a separate Bank Account. 
  4. Payment of the money only to the shareholders.
  5. The mode of payment must be in cash only. 
  6. Unpaid dividend account.

Amongst all these requirements, one of the most important is to have a separate bank account for payment of dividends. The companies need to maintain a separate bank account with a scheduled bank. The dividend must be deposited in the same account within a period of five days from announcing such dividends. A separate bank account is also opened for Unpaid dividends so that any such unpaid dividend is deposited in that separate account. This is according to the provision mentioned under Section 124 of the Act.

Now that we know the requirements of the payment of dividends, let us have a look at the conditions which need to be fulfilled in order to declare dividends. 

Depreciation

There are certain requirements that need to be fulfilled before the declaration of dividends.

  • Depreciation: Schedule II of the Companies Act, 2013 specifies the provision for depreciation on all depreciable assets. The depreciation on all such assets must be provided before declaring the dividends. 
  • Transfer to reserves: The company may add any amount of profits which was agreed to be provided in the documents of the company. It is only after this transfer to reserves, that declaration of dividends must be made.
  • Fee reserves: Any company must not pay dividends out of any reserves except fee reserve.
  • Set off previous year losses and depreciation: The companies must not provide dividends before setting off the loss from the previous year or depreciation that was not provided in that year.

Reserve Fund

According to the Companies Act, 1956, a compulsory amount needs to be transferred to reserves if the dividend declared exceeds 10 percent of the total profit. The table below represents the percentage of profits that need to be compulsorily transferred to the reserves.

Percentage transferred to dividends

Percentage that needs to be transferred to reserves

10%-12%

2.5%

12%-15%

5%

15%-20%

7.5%

Above 20%

10%

Compulsory reserves

These compulsory reserves got repealed in the Companies Act, 2013. According to the new Act, there is no mandatory requirement of putting any percentage of profits to reserves. The discretion rests with the company whether it wants to transfer anything to the reserve funds or not.

Unpaid dividend account

Section 124 of the Companies Act, 2013 specifies the treatment of unpaid dividends.

The definition refers to this account as an ‘Unpaid Dividend Account’. Any amount which was declared but is still unpaid shall be transferred to this account within 37 days of the declaration. The company shall make a list containing all necessary details of the persons who have not been paid the dividends. The persons who are entitled can claim their money from the company. If such a payment is not claimed within seven years, then the company can transfer the money to the Investor Education and Protection Fund, established under Sub-Section (1) of Section 125.

In India Awake for Transparency v. Union of India, the court verbatim said that,

“Thus, the shareholder continues to retain the title but loses agency. The company concerned is relieved of the responsibility of holding the shares or reflecting it in its list of shareholders.” When it was asked about the transfer of the amount to fund after seven years.

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Payment to registered holders

The payment shall be made only to the registered shareholders as per Section 123(5) of the Companies Act, 2013. The amount is payable in cash through cheque only. The payment may also be made to the shareholder’s order or banker after due authorization.

Effect of declaration

Effect on stockholder’s equity:

The stockholder’s equity can be calculated by subtracting Company’s liabilities from its assets. The type of Dividend issued determines the effect on stockholder’s equity. The value of dividends is deducted from its retained earnings.

Effect on cash:

The balance sheet has an effect where the cash is reduced after the declaration of dividend payments. So, the effect of the declaration comes on both cash and shareholder’s equity.

Interim dividend

When we wish to look at the legal aspect of the definition, we need to refer Companies Act, 2013. Section 2(35) of the Companies Act 2013, mentions the definition as ‘including interim dividend’. Interim dividend, as mentioned in the definition refers to those dividends which are declared between two annual general meetings. It is also essential for the companies to make a substantial amount of profit in order to declare interim dividends.

For example, declaration of an interim dividend of Rs. 0.005 per share on Feb 20th, but since interim dividends are paid out before the end of the fiscal year, the financial statements that accompany interim dividends are unaudited.

Payment of interest

Section 127 of the Act states that if there is a default in the payment of dividends, the company if such act has been done in full knowledge, is liable to pay such amount at 18 percent per annum until the default payment is made. This interest is paid on the amount which is unpaid and such an amount is known as ‘Dividend in Arrears’.

Investor Education and Protection Fund

Section 125 of the Act, mentions about the Investor Education and Protection Fund (IEP), where money gets transferred on certain occasions which are mentioned below:

  1. Money from the Central government for the purposes of this fund.
  2. Donations received on account of this fund.
  3. Amount of Unpaid Dividend Account under Section 124(5) of the Act.
  4. The amount lying in the IEP fund established under Section 205C of the Companies Act, 1956.
  5. Income from investments made under the fund.
  6. Income received under Section 38(4) of the Act.
  7. The matured debentures with companies.
  8. Any other prescribed amount.

The money of the fund can be utilized for the promotion of investor’s education, awareness, and protection. It can also be used for other purposes such as repayment of unpaid dividends, matured deposits, etc.

Capitalization of profits

Capitalization of profits refers to the transformation of retained earnings to the capital stock. It does not have any effect on shareholder’s equity because it is a mere transfer from one account to another account. It refers to the simple process of utilization of profits as the capital of the company.

Bonus shares

Bonus shares are those accumulated shares of the company which are given out additionally, without any extra costs on the basis of the number of shares held in the company. For instance, if Investor A holds 200 shares of a company and a company declares 4:1 bonus, that is for everyone one share, he gets 4 shares for free. That is a total of 800 shares for free and his total holding will increase to 1000 shares.

Accounts

We have talked about the dividends of a company, at length. We shall now talk about the accounts of the company. When we want to know more about the legal aspect of Accounts of a company, we have to refer to the Act. Section 128 of the Act states that every company must maintain true, and fair financial statements. The accounts must be at a place in India that can be easily accessed within seven days if there was a notice provided. The accounts may as well be placed in an electronic mode. If there is a branch outside India, the company shall keep the records in the registered office and a summarised copy of all returns must be sent periodically to the registered office if the company is registered under the Act.

When it comes to conducting any investigation, all the employees must cooperate in providing any required part of the accounts. It is specified that accounts of at least preceding eight years must be preserved in good order.

There are several important sections from the Companies Act that must be taken into account when we talk about the accounts of any company. The table below will represent all the other relevant provisions:

Section of the Companies Act, 2013

Matters dealt with

Section 129

Financial Statements of the Company

  • It should follow Schedule III of the Act.
  • It must comply with the norms in Section 133.
  • It must not display any deviation.

Section 130

Presenting the accounts on a court or a tribunal’s order. 

Section 131

Revising the financial statements in case of discrepancy. 

Section 132

Constitution of a National Financial Regulating Authority.

Section 133

The Central Government shall be making standards for the Company’s accounting standards.

Section 135

The company’s Corporate Social Responsibility is contained in the section.

Directors’ Responsibility Statement

Directors are responsible for the Company’s accounts and its accuracy. The directors release a statement known as the director’s responsibility statement, which assures on the account of the Companies Act, 2013 that the directors have taken due care in the preparation of the documents. The documents produced are true and fair, nothing is forged and everything which has been recorded contains due proof. The statement contains:

  1. The financial statements, which are prepared in accordance with the financial reporting framework provided by the law, gives a true and fair view of the financial position and profit or loss of the Company and the undertakings included in the consolidation are taken as a whole;
  2. The Strategic Report, covered in the Statutory Information, will generally include a fair representation of the development and performance of the business and the standing of the Company and the undertakings included in the consolidation will be taken as a whole, together with a description of the principal risks and uncertainties that they face; and
  3. The Annual Report and Accounts, which are taken as complete, will be fair, balanced and understandable and they will provide the necessary information for shareholders to calculate the Company’s performance, business model and strategy.

Preservation of books of account

The Act requires companies to preserve the statutory registers which contain the records of the Company’s accounts. These registers are required to be produced before the Registrar of Companies (ROC) within a limited period of time. The provided table below shall provide all the necessary books, which are required to be produced before the Registrar of Companies.

Sr no.

Necessary Document

The function of the necessary document

1.

Register of Companies

It contains all necessary basic details such as the Name, PAN CARD number, address, payment due dates, etc. 

2.

Register of Members of the Company

This contains several important lists such as,

  • The list for members separately.
  • The list for debenture holders.
  • The list for other security holders.

3.

Register for Key personnel Management

The list contains all necessary details about the director and the key managerial staff.

4.

Register of charges

Register of charges contains details of all the charges which were registered with assets and properties. The register must be updated at all times because of the tax importance that this register holds.

5.

Register of renewed and duplicate share certificates 

This register, as the name suggests, keeps a record of all renewed and duplicate share certificates.

6.

Register for employee stock options

Employees are provided a chance to invest in the company’s shares, this is known as Employee Stock Options. This register contains details of such shares.

Accounts to comply with accounting standards

The accounting standards are written policies and documents that provide standards for the recognition, measurement, treatment, presentation, and disclosures of accounting transactions in the financial statements. These help with comparing the financial accounts of this year with the previous years. The comparison helps in tracking the growth of the company.

The accounts of a company must comply with accounting standards once set because separate accounting standards have different norms, which are difficult to track. So, the companies are required to follow one set of accounting standards which will be easier for the law to authenticate and verify.

National Advisory Committee on Accounting Standards (NACAS)

NACAS was set up by the Companies (Amendment) Act, 1999. After the enactment, section 210A of the Companies Act, 1956 established this authority which would check that the companies are following the set accounting standards by the Central Government. However, with the introduction of the Act of 2013, a modified version of NACAS was introduced, known as the National financial regulatory authority. NFRA has two objectives:

  1. Formulating policies and standards for the companies.
  2. Regulatory nature, by way of which, it would help in the improvement of the quality of services provided by the companies.

Further, NFRA has the power to investigate in case of knowledge of any mishandling of accounts, which was not included in the NACAS. In fact, NFRA has all the powers of a civil court vested in the Civil Procedure Code, 1908. NFRA may also impose penalties if the offense is proved.

The intention of the legislature in forming the NFRA was to increase the powers vested in the NACAS so that, the implementation of the regulations may happen smoothly.

Right of inspection

Section 171 of the Act gives the members of the company, the right to information regarding the accounts of the company. It must be open for perusal at the time of the Annual General Meeting. These books should also be available for perusal in all business hours. In case, the company denies access to the books to any of the members, the ROC may have the books issued to the concerned person within a period of thirty days from such request.

Financial Statements

Section 129 of the Act provides for the maintenance of the financial statements. Section 2(40) must include a balance sheet, profit and loss account/income and expenditure account, cash flow statement, statement of changes in equity. Schedule III includes detailed requirements of the financial statements.

Audit

Audit is an examination of the books and accounts of the company. The examination also includes statutory records, and vouchers of an organization to ascertain the fairness of the financial statements, as well as non-financial disclosures, in order to present a true and fair view of the concern. There are two main types of audits: external audits, internal audits.

  1. External Audits: External Audits are performed by Certified Public Accounting firms, in order to perform an external check.
  2. Internal Audit: This is to make improvements in the company. 

Let us now have a look at the auditor, who performs these audits.

Appointment of auditors

Section 139 of the Companies Act, 2013 states the appointment of an Auditor. In the first annual general meeting, the company shall appoint a person as to its auditor. In each annual general meeting, there must be ratification by the members. 

  1. Written consent of the auditor to such appointment
  2. Certificate that

(a) The auditor is eligible for appointment and is not disqualified for appointment under the Act, the Chartered Accountants Act, 1949 and the rules or regulations made thereunder;

(b) The proposed appointment is as per the term provided under the Act;

(c) The proposed appointment is within the limits laid down by or under the authority of the Act;

(d) The list of proceedings against the auditor or audit firm or any partner of the audit firm pending with respect to professional matters of conduct, as disclosed in the certificate, is true and correct.

After the appointment, the auditor must have a meeting with the ROC within 15 days of appointment. These rules must comply with ADT-1.

Remuneration of auditor

Section 142 of the Act states that the remuneration of the auditor will be decided in the same way that the auditor was appointed. Remuneration includes expenses incurred in the process connected with the audit or any expenses that the company had facilitated with. It does not include any remuneration related to any service other than related to the audit itself. Schedule III of the Act also mentioned that the payment made to the auditors must be disclosed.

Removal

The auditor appointed may be removed from his office before the expiry of his term only by way previous approval of CG and a special resolution of the company to be passed in a general meeting within 60 days of receipt of approval of CG. However, it must be noted that the auditor is given a fair chance to represent himself or herself. The auditor must provide a statement to the ROC within a period of thirty days from the date of removal. The auditor may be punished with a fine between 50,000-5,00,000 in case of non-compliance.

Qualifications

An auditor must comply with the norms of the Companies Act, 2013.

  1. Individual: Only if is a CA holding certificate of Practice as per Section 2(17) of the Companies Act, 2013.
  2. Audit Firm/LLP: Majority of partners who are CA are practicing in India, appointed in Firm name. Only the partners who are CA’s are authorized to act as auditors and sign.

Powers and duties of auditors

The powers can also be described as the rights of the auditor. The rights are listed below:

  1. The auditor may inspect the books of accounts of the company.
  2. The auditor may ask for any clarifications.
  3. The auditor must get the invitation to attend the general meeting.
  4. The auditor has the power to make any statements in the meeting.
  5. The auditor must be indemnified for the expenses and losses incurred.
  6. The auditor has the power to visit any branches of the company.

With a lot of power comes a lot of responsibility. The auditor has the below-mentioned duties:

  1. They must make special inquiries and investigations in order to ascertain the truth.
  2. The report made by the auditor must be made available to the shareholders.
  3. If there are any answers in negative, they must state the reason for doing so.
  4. The matters related to the Central Government must be included in the Report.
  5. The audit report must be signed by him.
  6. The auditor must give a report upon the prospectus.
  7. The statutory report must be signed by him.
  8. They must declare the company solvent.
  9. They must assist in all the investigations.
  10. They must assist the Advocate General.

Default in disclosing fraud

The auditors also have a duty to report fraud (if any). If the auditor defaults in disclosing fraud committed by the companies, the auditor must face heavy penalties in view of the same. The penalties depend upon the size of the fraud, not disclosed.

Special audit

A special audit is defined as an audit that is carried out in a specific area of organizational activity. These are helpful when we wish to present the analytics of a specific department of work. For instance, Cost Audits are specifically done in order to check the cost of the products supplied. 

Power of Registrar to call for special information

In order to facilitate investigations, the ROC has the power to call for documents containing information regarding the accounts of the company. The power is also eligible for random scrutiny checks on the companies. Section 234 of the Companies Act, 1956 mentioned the power to call for information but the present Act does not definitively mention the power. 

This power helps the ROCs to check on the companies. The companies are also aware of this fact and therefore, they refrain from making any fraudulent representation in the documents.

Seizure of documents by Registrar

The registrar has the power to seize any documents that he might feel may have discrepancies within them. Section 234A of the Companies Act, 1956 mentioned this power. But, the present Act of 2013, does not contain such a provision.

Audit of cost accounts

The products go through various cost centers before getting actually made into a finished product. The accounting starts from the raw material stages itself. This helps with understanding the standard cost of the product. These financial accounts come under the ambit of cost accounting and the audit of cost accounts is known as Cost Audit.

The cost audit is performed to undertake the verification of the cost accounts of the company. The auditing is performed in order to check whether the cost accounting plan has been adhered to. Frauds can be prevented to a large extent if the cost audits are performed in a prescribed manner.

Cost audits have various advantages to the management as well as auditors. By cost audits, wastage in the material can be checked, inefficiencies in the production can be calculated in terms of money and can be accounted for, errors in costing techniques can be checked. The advantages of cost audits are very facilitative for the management as well as the auditors.

Conclusion

Dividends, accounts, and audits are the three most important parts of the company. This article presented a legal perspective on these aspects of a company. The repeal of the Companies Act, 1956 shows the progressive thought process of Indian Legal standards. After the New Act brought in 2013, the laws have transformed into the requirements of current global challenges as well. We look forward to the accurate implementation of these laws so that India can become one of the best financially regulated countries.

References

Basil S. Yamey, Aspects of the Law Relating to Company Dividends.


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