Computation of Available Surplus and Highlighting Allocable Surplus, Set-on & Set-off of Allocable Surplus
Introduction
1. Available Surplus
Available surplus refers to the total amount of surplus or profit that a company can distribute after fulfilling all legal obligations and adjustments. This surplus is considered after deducting all necessary provisions, reserves, and amounts set aside for various purposes such as taxes, depreciation, and specific statutory reserves. The available surplus can be divided into two main categories:
- General Surplus (after-tax profits): This is the leftover profit after paying taxes, interest, and other operational expenses.
- Allocable Surplus: This is the portion of the available surplus that is available for distribution among the company's employees, shareholders, and other stakeholders.
In simple terms, available surplus is the remaining profit or earnings that the company has after meeting all the essential financial commitments. The amount of available surplus influences decisions about dividend distribution, employee bonuses, and other financial allocations.
2. Computation of Available Surplus
To compute available surplus, a company must follow the following steps:
Step 1: Start with Gross Profits
This is the total revenue earned by the company from its core operations, such as sales, services, and any other operating activities.
Step 2: Deduct Operating Expenses
These include costs incurred during the day-to-day operations of the business, such as salaries, rent, utilities, material costs, and other operational expenses.
Step 3: Deduct Interest Expenses
Interest paid on loans, debentures, or any borrowings must be deducted from the gross profits.
Step 4: Deduct Taxes
The next deduction is for taxes, including corporate tax, capital gains tax, and other applicable taxes.
Step 5: Deduct Depreciation
Depreciation on assets (both tangible and intangible) needs to be considered as a non-cash expense. This amount is deducted from the gross profits.
Step 6: Set Aside Provisions
Certain provisions for contingencies, like bad debts, provisions for taxation, etc., may need to be set aside as per the statutory or accounting requirements.
Step 7: Arrive at Net Profits
After these deductions, the remaining amount is the net profit, which becomes the starting point for determining the available surplus.
Step 8: Adjust for Previous Losses
If the company has carried forward losses from previous years, these must be adjusted before calculating the available surplus. If previous losses have been carried forward, the available surplus will be reduced by the amount of such losses.
3. Allocable Surplus
Allocable surplus is a subset of the available surplus and refers specifically to the portion of profits that a company can legally allocate for specific purposes, such as the payment of dividends to shareholders, bonuses to employees, or contributions to statutory reserves.
According to the provisions of the Companies Act, 2013, and similar regulatory frameworks, allocable surplus includes the profit left after the following deductions:
- Statutory Reserves: These are mandatory reserves that the company must set aside by law. For example, a company may be required to set aside a portion of its profits as a statutory reserve for specific contingencies or for future business growth.
- Depreciation: The company must also account for depreciation as a deduction from the profits before allocating the remaining surplus.
- Previous Losses: Any losses from previous financial years must be offset against the available surplus. The loss must be carried forward and adjusted against current profits before calculating allocable surplus.
- Interest on Loans and Taxes: The company must ensure that any outstanding interest or tax liabilities are deducted from the profits before the remaining funds are allocated for distribution.
The portion of profit remaining after these necessary deductions is the allocable surplus, which can be utilized for distribution according to the company's corporate policies or legal obligations.
Legal Framework for Allocable Surplus
Allocable surplus is often defined by a company’s internal rules or according to legal guidelines, such as:
- Dividends to Shareholders: A company may choose to distribute part of the allocable surplus to shareholders in the form of dividends.
- Employee Bonus or Profit Sharing: Some companies may choose to set aside a part of the allocable surplus for employee welfare schemes or profit-sharing bonuses.
- Retained Earnings: Companies may retain some of the allocable surplus for future investment, business expansion, or to hedge against future financial uncertainty.
4. Set-On & Set-Off of Allocable Surplus
What is Set-On?
Set-on refers to the process of carrying forward unutilized allocable surplus to the next accounting period. When a company does not distribute the entire allocable surplus in a given year (perhaps due to reinvestment needs or to maintain cash reserves), this unutilized portion can be carried forward to the subsequent year.
For example, if the allocable surplus for Year 1 is ₹10 million, and the company only distributes ₹6 million to shareholders or employees, the remaining ₹4 million may be set on to the following year’s surplus, which can be used for future distributions.
What is Set-Off?
Set-off, on the other hand, refers to the process of using the accumulated or unallocated surplus of previous years to adjust or compensate for a current year's deficit or losses. If, in any given year, the company faces a loss or does not have sufficient allocable surplus to meet its distribution obligations (like dividends or employee bonuses), it can use the surplus carried over from previous years to make up for this shortfall.
For example, if the available surplus in Year 2 is ₹8 million, but the company faces losses and cannot meet its financial obligations, it may choose to set off part of the surplus from Year 1 (which had ₹4 million unused surplus) against the Year 2 deficit. The surplus carried forward thus "offsets" the current shortfall.
Rules Governing Set-On and Set-Off
- Statutory Provisions: In accordance with Indian law, the surplus from previous years can be set-off to meet current-year obligations but must be done in compliance with regulatory guidelines to ensure that the financial integrity of the company is not compromised.
- Bonus Payment: The payment of bonuses to employees or dividends to shareholders can be adjusted using the set-off mechanism if previous years' surplus is available.
- Limits on Set-Off: There are generally no strict limits on the amount of surplus that can be set off, but companies must maintain proper accounting records and ensure they do not deplete their reserves to the point where they affect the company’s liquidity.
5. Conclusion
The computation of available surplus, allocable surplus, and the methods of set-on and set-off are critical concepts for the financial management and regulatory compliance of a company. The available surplus is derived after deducting all necessary expenses and obligations, while allocable surplus refers to the portion that is specifically available for distribution to stakeholders.
Understanding the concepts of set-on and set-off is vital for companies in managing their profits across financial years, ensuring that they can smoothly handle distributions even in the event of losses or insufficient surplus in any given year. With careful planning, companies can effectively manage their financial resources, contributing to their long-term sustainability and growth.
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