Accounting Procedures Applied to Periodic Income

Accounting procedures applied to periodic income

The important difference between a company and an un-incorporated business such as a sole trader lies in the manner in which periodic income is appropriated. In the case of the un-incorporated business, the net income belongs to the owner and is transferred to the capital account at the end of the accounting period. By contrast, once the net income of a company has been ascertained, the board of directors have to decide the proportion which should be paid out to shareholders as dividends and the proportion which should be retained.

In considering the manner in which the net income should be appropriated, the following factors are important:

(a) Adequate provision should be made in respect of corporation tax payable on the net income for the year. In this connection, under- or over-provisions in respect of previous years have to be taken into account.

(b) Adequate provision should be made for anticipated expenditure on the replacement of fixed assets. During periods of inflation, in particular, the cost of replacing fixed assets exceeds amounts provided for in the provision for depreciation.

(c) Adequate provision should be made for capital expenditure which is planned to be financed out of earnings.

(d) Where a company wishes to provide a degree of stability in the level of yearly dividends by means of a dividend equalization account, care should be taken that sufficient reserves are accumulated in that account.

(e) The level of retention of income should also be dictated by working capital requirements, and for this purpose, transfer of net income to a general reserve may be made.

It is quite common for companies to distribute only about half their after-tax income to shareholders. Usually an interim dividend is declared during the accounting period in anticipation of a final dividend, which is declared after the final results for the year have been ascertained.


Delta Expandite Co made a net income of £5 million for the year ended 31 December 19X0. Estimated corporation tax payable on those profits was calculated at £2 million. The directors recommended the following appropriations of the distributable net income in the accounts laid before shareholders at the annual general meeting:

(a) the fixed assets replacement reserve should be increased by £200,000;

(b) the capital expenditure reserve should be increased by £500,000;

(c) the dividend equalization reserve should be increased by £300,000;

202 Accounting Theory and Practice

(d) the general reserve should be increased by £750,000;

(e) an interim dividend of £200,000 having been declared during the year, the directors proposed a final dividend of £1 million to be paid to ordinary shareholders registered at the close of business on 28 February 19X1. (Note: there was no other class of share in issue.)

Note that it is customary to close the register of shareholders for a brief period after the close of the accounting period for the purpose of determining the names of shareholders entitled to the dividend. The reason for this is that share dealings on the Stock Exchange continue, and daily the company is faced with share transfer forms to process as shareholders sell their shares and are replaced by new shareholders. Freezing the register of shareholders allows a list of shareholders to be drawn up to whom dividends are paid. If they have already sold their shares, and the buyers have not yet registered the transfer, the conditions of sale apply to the dividend entitlement. Usually, shares are traded on the Stock Exchange aim dividend (with dividend) until the formal dividend declaration, when they go ex dividend, that is, they are sold without the dividend declared.

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Loan capital

There is very little difference in the accounting treatment of loan and share capital. Registers of debenture-holders and of holders of unsecured notes are kept, and the method of issue is identical to that of shares insofar as the issuing process tends to be conducted on behalf of the company by merchant bankers. Debentures may be issued at par, at a premium or at a discount. Premiums received on the issue of debentures are regarded as capital profits, and are usually transferred to a capital reserve account. Discounts allowed on the issue of debentures are treated as capital... see: Loan Capital