Treatment of Special Items

1. Interest on Debentures:

Debentures interest is a business expensed and therefore, it is a charge against profit and as such profit and loss account is debited with the total amount of interest payable during the accounting year whether the company has earned the profit or not.

Trial Balance of Sharp Ltd. As on 31.3.2012
Dr.		Cr.
	Rs.	Rs.
14% Debentures		20,00,000
Interest on debentures	70,000

Interest for the full year on Rs. 20,00,000 at 14 per cent p.a. is Rs. 2,80,000. Since an amount of Rs. 70,000 is shown in the trial balance against interest, we may assume that an amount of Rs. 2,10,000 is outstanding. Usually, debenture interest is payable every six months.

In the given illustration we may assume the due dates of interest to be June 30 and December 31 of every year. While the interest due on June 30, 2011 has been paid, the amount due on December 31, 2011 has not been paid and in addition, interest has accrued for the three months period up to March 31, 2012.

In the profit and loss account, the interest on debentures will be shown as follows:

Profit and Loss Account of Sharp Limited
	Rs.	Rs.
To debentures interest	70,000
Add: Outstending interest	2,10,000	2,80,000

The interest of Rs. 1,40,000 being the interest due for the six month period up to December 31, 2011, is termed as “interest accrued and due and though this outstanding amount is a short- term liability, as per Companies Act, it must be shown in the balance sheet along with the amount outstanding in respect of debentures.

The interest of Rs. 70,000 being the interest due for the three month period up to March 31, 2012, is ‘termed as interest accrued but not due’ since the next due date for payment of interest is only June 30, 2012. Interest Accrued but not due should be shown in the Balance Sheet as a current liability.

Balance Sheet of Sharp Limited as on 31.03.2012
	Rs.	Rs.
Liabilities: Secured Loans 14% Debentures Add: Interest Accrued and Due	20,00,000 1,40,000	21,40,000
Current Liabilities and Provisions Interest Accrued but not due on Debentures		70,000

2. Income Tax on Interest on Debentures:

Payment of interest on debentures is subject to compulsory deduction of income tax at the current prescribed rates given in the Finance Act. The Accounting entry is

Interest on Debentures Account	Dr.	(with the gross account)
To Debentures holders Account		(with the net amount payable)
To income-tax payable account		(with the amount of the tax on the gross amount)

3. Discount on the Issue of Debentures:

Discount or costs, e.g., commission, brokerage, etc. incurred on the issue of debentures should normally be written off as early as possible but in no case later than the date of redemption. The unwritten balance will be shown in the balance sheet under ‘Miscellaneous Expenditure’ on the Asset side.

4. Preliminary Expenses:

Such expenses include the costs of formation of a company and since their amount is usually large, it is not desirable to write off them in one year. Instead preliminary expenses are spread over a number of years and profit and loss a/c is debited with certain fraction every year. The unwritten amount is shown under Miscellaneous Expenditures on the asset side of the Balance Sheet.

5. Call-in-Arrears:

This item represents the amount not paid by the shareholders on the calls made on them by the company. If this item is given in the trial balance, it is shown in the balance sheet on the liabilities side as a deduction from the called up amount under the main head of share capital. But if this item is given outside the trial balance as an adjustment, it would mean that the trial balance shows only the paid up capital and not called up capital. The amount of call-in-arrears is then added to the paid up capital to make the later as called up capital and then deducted again.

6. Calls-in-Advance:

It is a debt on the company until the calls are made and the amount received in advance is adjusted. A company may also pay interest on calls-in-advance and the rate of interest is usually stated in the articles. It should be treated as a current liability and shown under the heading current liabilities and provisions.

7. Auditors’ Payments:

Payments made to auditors for auditing the accounts and for doing any other work for the company should be mentioned separately.

8. Managerial Remuneration:

The remuneration paid to managerial personal (e.g., directors, managing directors or manager) of a company in any form or mode is a charge against profits and thus shown in the debit side of the profit and loss account. The mode of payment of the remuneration may include the fee for attending the meetings of the Board, monthly salary, a fixed percentage of profit and so on.

The Companies Act has imposed severe restrictions on the managerial remuneration payable by a public company or a private company which is a subsidiary of a public company.

Section 198 (i) provides that the total managerial remuneration in respect of any year is subject to an overall limit of 11 percent of the net profits of the company in that year.

9. Income-Tax:

Dividends to both the equity and the preference shareholders can be paid only out of profits available after taking into account the income-tax. The profits on which income-tax is payable is termed as taxable profits and the calculation of taxable profits is based on the provisions as per the Income-Tax Act.

Though the actual amount of tax can be calculated only when the books of accounts are closed for the accounting period and profits are ascertained, the Income-Tax Act requires a business to pay advance tax by forecasting the likely profits that would accrue during the year.

Another point to be noted in the case of Income-tax is that though a company may determine the tax liability, pay the tax and file its return, the income-tax officer will scrutinize the return and assess the tax payable by even re-computing the taxable profits.

If the income-tax officer arrives at taxable profits which differ from that stated by the company in its return, then the tax assessed and to be settled will also differ. The process of assessment may take quite some time to be completed and until such completion the exact tax liability will not be known to the company.

Thus, the accounting treatment of income-tax must take into account the following three stages:

(i) Payment of advance income-tax.

(ii) Determination of the tax liability by the company from its books of accounts, making a provision for such liability and payment of difference, if any, between advance tax and tax now computed.

(iii) Completion of the assessment by the income-tax officer.

The concepts of ‘previous year’ and ‘assessment year’ have also to be understood to follow the accounting treatment of income-tax. Assessment year means the period of twelve months starting from April 1 of every year and ending on March 31 of the next year.

The income of the previous year of a business is taxed during the following assessment year at the rates prescribed for such assessment year by the Finance Act. The previous year is defined as the financial year or the period of twelve months starting from April 1 of every year and ending on March 31 of the next year.

When advance tax is paid, the journal entry to record this would be

Advance Income-tax Accounts	Dr.
To Bank A/C

For example, if an advance tax of Rs. 3, 50,000 is paid by a company for the previous year 2012 in 2012-13, the entry to record this would be

Advance Tax for Assessment Year 2012-13 Account	Dr.	3,50,00
To Bank Account			3,50,000

Though the above transaction has been journalized to explain the dual aspects in reality, the payment of advance tax would be recorded in the cash book and the debit aspect posted into the ledger from the cash book. Thus, while preparing the trial balance as on March 31, 2012, the advance tax for assessment year, 2012-13, will be included in the trial balance at debit balance of Rs. 3, 50,000.

Let us assume that in the example cited above, the company determines its tax liability as Rs. 3, 42,500 after drawing up the Profit and Loss Account for the year ending March 31, 2012. This liability must be provided for by passing the entry as,

Profit and loss Account	Dr.	3,42,500
To provisions for income-tax account			3,42,500

While the tax liability will appear as an expense in the profit and loss account, the provision for income-tax will be shown in the Balance Sheet as a current liability and the Advance Tax of Rs. 3, 50,000 paid will be shown as an advance on the asset side of the balance sheet.

Another acceptable method of presentation is to set off the advance and the provision relating to the same assessment year against each other and take only the net amount either to the liability or asset side of the balance sheet. In the example given above, since the advance exceeds the provision, the net amount would be presented as follows.

Balance Sheet as on March 31,2012
Assets	Rs.	Rs.
Loan and advances
Advance tax for Assessment year 2012-13	3,50,000
Less: Provisions for tax for Assessment year 2012-13	3,42,000	7,500

Till such time the assessment is completed, the balances in the advance and provision accounts will be carried forward. To continue with the above example, if the assessment is completed in December 2012 and the tax liability is arrived at by the Income-tax Officer at Rs. 3, 60,000,

The accounting treatment will be as follows:

1. The provision for tax is short of the actual liability by Rs. 17,500. The company will have to provide for this extra liability. In the Profit and Loss Account for the year ended March 31, 2013 the increase in liability will be provided for by making the following entry.

Profit and loss Account	Dr.	17,500
To provisions for income-tax account year 2012-13			17,500

The above entry will be in addition to the entry required to be passed in respect of tax payable for the financial year 2012-13.

2. Since the assessment has been completed, the advance tax account can be closed by transfer to the Provision account.

The journal entry for the transfer will be:

Provisions for income-tax account year 2012-13	Dr.	3,50,000
To advance tax for Assessment year 2012-13			3,50,000

3. The balance of tax payable amounting to Rs. 10,000 (Rs. 3,60,000 – 3,50,000) must be paid shortly after the completion of assessment. When the short-fall in tax is paid, the entry will be

Provisions for income-tax account year 2012-13	Dr.	10,000
To Bank a/c			10,000

With the recording of the above entries, the balance sheet as on March 31, 2013, will not list any items pertaining to tax payable for Assessment Year 2012-13.

The ledger accounts are given below:

 

Dr.	Advance Tax for Assessment Year 2012-13				Cr.
2012	Particulars	Rs.	2013	Particulars	Rs.
	To balance b/d	3,50,000	March, 31	By provision for Income-tax Account	3,50,000
		3,50,000			3,50,000
Dr.	Provisions for Income tax Account Year 2012				Cr.
Date	Particulars	Rs.	Date	Particulars	Rs.
2012 Dec.   2013 March 31	To Bank a/c. To advance for year 12-13	10,000   3,50,000	2012 April 1   2013 March 31	By balance b/d By Profit & Loss account	3,42,500   17,500
		3,60,000			3,60,000

Note:

Adjustments relating to income tax of the previous year is normally done by debiting or crediting the P/L appropriation a/c so that current operating profits are not distorted. Provision for current year’s tax is, however, debited above the line.

10. Dividends:

Dividends may be defined as the share of profits that is payable to each shareholder of the company. The Companies Act lays down that dividends can be paid out of profits only and prohibits the payment of any dividend out of capital. Also, dividends shall be paid in cash only.

A company may pay dividends from any or all of the three following sources:

(i) Profits of the current year

(ii) Undistributed profits of previous years

(iii) Moneys provided by the Central or any State Government for the payment of dividends in pursuance of a guarantee given by the government concerned.

The directors generally recommend the percentage of dividend payable on the equity shares. The shareholders in the annual general meeting may pass a resolution adopting the recommendation or may lower the percentage recommended. The shareholders do not have the power to enhance the dividend recommended by the Directors. The percentage adopted must be applied only on the paid-up capital.

For example, let us assume that the Directors of Sunshine Limited propose a dividend of 15 per cent for the equity shareholders which is adopted by the shareholders. The called up equity capital of the company is Rs. 50, 00,000 and there are calls in arrears to the extent of Rs. 40,000.

The dividend payable in the example would be calculated as (15/100) × (50, 00,000 – 40,000) = Rs. 7, 44,000. Of late, companies have started declaring dividends as a percentage of the Profit After Tax also.

The dividend recommended by the directors is termed as ‘Proposed Dividend’ till such time it is adopted by the shareholders in the annual general meeting. The entry to record proposed dividend is,

Profit and Loss A/c Cr.

  To proposed dividend A/c

The proposed dividend will be classified as a provision and shown on the liability side of the balance sheet. The dividend finally decided by the shareholders in the annual general meeting as payable is termed as ‘declared dividend’.

Any dividend declared must be paid within forty-two days from the date of declaration. Hence, a declared dividend must be classified as a current liability in the balance sheet of the company.

Though dividends can be declared only by a resolution of the shareholders, if the articles of the company permit, the Directors can declare an interim dividend between two annual general meetings. When interim dividend is paid the entry to record the payment will be,

Interim Dividend A/c Dr.

  To Bank A/c

The interim dividend paid during a year will appear in the Trial Balance of the Company as on the last date of the accounting period and will be transferred to the debit side of the profit and loss appropriation a/c as it is an item of appropriation of profits.

Dividend is generally paid by posting the dividend warrants to the shareholders. The dividend warrants must then be presented to the company’s bank which will make the payment. Sometimes, a portion of the dividend declared may remain as unpaid simply due to the fact that such dividend has not been claimed by certain shareholders.

Any unpaid or unclaimed dividend is a current liability and is shown on the liabilities side of the balance sheet. The company should transfer any unpaid dividend within forty-nine days from the date of declaration of the dividend to a special bank account.

If the dividend is not claimed for a period of three years from the date of transfer to the special bank account than the unclaimed amount must be transferred by the company to the general revenue account of the Central Government. After such a transfer, any shareholder entitled to claim such dividend may claim it from the Government.

11. Interest Out of Capital:

Though the Companies Act provides that dividends to shareholders are payable only out of profits, in certain circumstances with the previous sanction of the Central Government, interest may be paid to shareholders out of capital.

The circumstances as specified by Section 208 of the Companies Act are as below:

1. Where any shares in a company are issued for the purpose of raising money to defray the expenses of the construction of any work or building, or the provision of any plant, and
2. Such construction or provision of plant cannot be made profitable for a lengthy period.

In the above circumstances, if the company is authorized by the articles or by a special resolution, it may pay interest on so much of that share capital as is for the time being paid-up, for a specified period and charge such interest to capital as part of the cost of the construction of the work or building or the provision of the plant.

The payment of interest shall be made only for such period as may be determined by the central government. The period, in any case, cannot extend beyond the close of the half year next after the half year during which the work or building has been actually completed or the plant provided. The rate of interest cannot exceed four per cent per annum or such other rate as the Central Government may notify.