Presentation on theme: " CHAPTER NO. 3 MANAGEMENT OF EARNING. The term management of earnings means how the earnings of a firm utilized i.e. How much is paid to the shareholders."— Presentation transcript:
The term management of earnings means how the earnings of a firm utilized i.e. How much is paid to the shareholders in the form of dividends & how much is retained & ploughed back in the business. The way the companies apportion their earnings between dividends & retention is known as management of earnings ‘ Management of income includes the management of each phase of the company’s business because, the minutest activity of the business usually involves income or expenditure” GERSTENBERG
MANAGEMENT OF EARNINGS INCLUDES 1. (A) DETERMINATION OF PROFITS (B) DETERMINATION OF SURPLUS (C) CREATION OF RESERVE 2. PROVISION FOR DEPRECIATION & DEPRECIATION POLICY 3. DECLARATION OF DIVIDEND & DIVIDEND POLICY 4. RETAINED EARNINGS & PLOUGHING BACK OF PROFITS (SELF- FINANCING)
For correct reporting to the shareholders For declaration of dividends, For ascertaining the operating efficiency of the company For deciding about the future expansion &growth For ascertaining the intensive use of capital For determining the credit worthiness of the firm For payment of correct taxes For determining the basis of mergers and amalgamations For ascertaining the importance of the industry in the national economy
INCOME FROM OPERATIONS OF THE BUSINESS IS THE MAIN SOUREES OF PROFITS INCOME FROM BUSINESS THIS INCLUDES INCOME FROM SUCH SUBSIDIARY SOURCES WITH UNCERTAINTIES INCOME FROM OTHER SOURCES THIS INCLUDES FUNDS FROM THE INVESTMENTS IN THE GOVERNMENT SECURITIES, BONDS, SHARES AND DEBENTURES ETC. INCOME FROM INVESTMENTS
Surplus according to one school of thought The balance remaining after deducting the liabilities and share capital from the total assets is known as surplus. In the opinion of other school Surplus represents the undistributed earnings of the company i.e., the balance of profits remaining after paying dividends to the shareholders. Still there are others in whose opinion Surplus is a left over which represents an addition to assets that is carried over on the equity side.
SURPLUS † WELCOME SIGN BY MANAGEMENT TYPE OF BLANKETS COVERING MANY CORPORATE PURPOSES REFLECTS SOUND ESRNING OF THE CONCERN ENABLES COMPANY TO FOLLOW STABLE DIVIDEND POLICY CUSION TO ABSORB THE SHOCKK OF THE BUSINESS AS WELL AS OF ECONOMY
1. EARNED SURPLUS - The use of the term surplus as accumulation of past earnings accounts for its common identification with earned surplus. 2. CAPITAL SURPLUS – It is that part of the surplus which is not related directly to the operating results of the business. 3. SURPLUS FROM UNREALISED APPRECIATION OF ASSETS - During prosperity or boom the value of fixed assets may increase or intangible values may be added by accounting entries. 4. SURPLUS FROM REALISED APPRECIATION OF ASSETS - The sales of assets at price in excess of book values may result in realised surplus.
5. SURPLUS FROM MERGERS, CONSOLIDATION & REORGANIZATIONS - These are generally accompanied by an upward valuation of assets, the resulting surplus may be larger than the total of that resulting in an increase in surplus. 6. Surplus from reduction of share capital- in the period of adversity, companies may create a surplus by reducing the liability of their stated capital 7. Surplus from secret reserves – this is one which is not disclosed in the balance sheet. 8. Paid in surplus. – it raises from the issue of shares at premium.
1. USES OF EARNED SURPLUS 2. USES OF CAPITAL SURPLUS Reducing the value of fixed & working capital Writing off intangible assets Equalizing the rate of dividend Financing schemes of expansion & growth Absorbing the shocks of business cycles Supplementing other reserves For expansion & growth For protecting investments against a decline in values For providing funds to working capital For writing down of operating losses For absorbing depreciation
UNDER VALUATION OF ASSTS OVER STATEMENT OF LIABILITIES o Charging excessive depreciation o Charging capital expenses as revenue o Writing off assets by charging against surplus Showing a contingent liability as an actual liability Use of fictitious liabilities Providing excessive provision for taxation
It refers to that amount set aside out of profits to cover any liability, contingency, commitment or depreciation in the value of assets. If amount equal to reserve are invested in out side investments the reserve is called reserve fund. IN MODERN DAYS The term reserve used only in connection with restriction on, or appropriation of retained earnings.
It is that part of profits which is set aside to meet any future unknown contingency or emergency. 1. GENERAL RESERVE This is created for some definite or specific purpose i.e., Dividend equalization reserve 2. SPECIFIC RESERVE These reserves consist of uncontributed revenue gains consisting of profits made in the ordinary course of business 3. REVENUE RESERVE These are created to strengthen the financial position of the company. 4. CAPITAL RESERVE Theses reserves are set up to off set the loss of value of some assets such as plant &machinery, Account receivables 5. ASSETS RESERVE
These are the part of shareholders equity to provides cushion against future risks 6. PROPRIETARY RESERVE These reserves may be provided for current as well as emergency liabilities 7. LIABILITY RESERVE It is merely a surplus appropriation that is included in shareholders’ equity. 8. FUNDED RESERVES. This fund is built up by regular contribution/ appropriation out of profits & the amount of interest on such contributions & the interest itself. 9. SINKING FUND RESERVES A secret reserve is a surplus which although exists in a business but is not disclosed in the balance sheet. 10. SECRET RESERVE
The ploughing back of profits is a technique under which all profits of a company are not distributed amongst the shareholders as dividend, but a part of profits is retained or reinvested in the company. This process of retaining and utilization year after year in the business is known as ploughing back of profits. This is also known as self financing process Internal financing process Inter financing process
1. EXPANSION &GROWTH OF BUSINESS 2. CONTRIBUTION TOWARDS CRRENT &FIXED NEEDS 3. IMPROVING THE EFFICIENCY 4. MAKING COMPANY SELF DEPENDENT 5. REDEMPTIONS OF LOANS & DEBENTURES 6. REPLACEMENTS OF OLD ASSETS
REINVESTMENT DEPEND UPON EARNING CAPACITY DIVIDEND POLICY TAXATION POLICY FUTURE FINANCIAL REQUIREMENTS DESIRE & TYPE OF SHAREHODERS
ADVANTAGES TO THE COMPANY A cushion to absorb the shocks of economy Economical method of financing Aids in smooth & undistributed running of the business Helps in following stable dividend policy Flexible financial structure. Makes the company self dependent To redeem long term liabilities ADVANTAGES TO THE SHAREHOLDERS Increase in the value of shares Safety of investment Enhanced the earning capacity No dilution of control Evasion of super taxes ADVANTAGES TO THE SOCIETY OR NATION Increases the rate of capital formation Stimulates industrialization Increases productivity Decreases the rate of industrial failure Higher standard of living
1. Over capitalization2. Creation of monopolies3. Depriving the freedom of the investors4. Misuse of retained earning5. Manipulation in the value of shares6. Evasion of taxes7. Dissatisfaction among shareholders
FORMULA OF COST OF RETAINED EARNINGS FORMULA OF COST OF RETAINED EARNINGS TO MAKE ADJUSTMENTS OF TAX & COST OF PURCHASING NEW SECURITIES Kr = COST OF RETAINED EARNINGS D = EXPECTED DIVIDEND NP = NET PROCEEDS OF SHARE ISSUE G = RATE OF GROWTH Kr = COST OF RETAINED EARNINGS D = EXPECTED DIVIDEND NP = NET PROCEEDS OF SHARE ISSUE G = RATE OF GROWTH T = TAX RATE b = COST OF PURCHASING NEW SECURITIES, OR BROKERAGE COSTS