INCOME, DIVIDENDS AND SURPLUS 1. Income statement..—The financial policy of a corporation cannot be intelligently determined with out a fairly accurate knowledge of its present condi tion and operating results. If the business is well systematized and the transactions properly recorded upon the books, the present condition will be reflected in the balance sheet, which sets out in more or less detail the assets and liabilities of the company. The extent and profits of current operation, however, are summarized in the form of an income statement. For details the reader is referred to the Texts on accounting subjects.' It is necessary here to discuss briefly the income account, since the policy regarding dividends and surplus depends directly upon it.
The usual form of income statement, subject to many variations, is as follows: If business has been conducted at a loss, the deficit for the year is a charge against previous surplus, or, in the absence of surplus, it directly impairs the capital of the company. In such case, there is nothing to discuss concerning dividends and surplus, because there are no earnings to divide.
2. Sources of income.—Operating revenue should be classified according to the kinds of business carried on. Operating expense includes the cost of main tenance and of the material, labor and supplies re quired to run the business. To the income from operation must be added income from other sources, such as interest and dividends upon the securities of other companies, rentals from property owned, in terest upon bank deposits, gifts to the corporation, and premiums earned upon the sale of capital assets or of additional stocks and bonds. Income from miscellaneous sources is likely to be irregular, has no direct relation to operating income and should, there fore, be separated from it.
From the gross income thus derived, all fixed and contingent charges such as interest, rental, taxes, etc., must be met. The amount then remaining is the ac tual net earnings of the company, available for divi dends. The portion of the net earnings not paid out
to stockholders is retained in the business and carried to the surplus account.
Unless the income statement is made up honestly and accurately, it is of no value. Unfortunately many American corporations keep such unsatisfactory records that they are unable to present an accurate balance sheet or income statement. The cost of operation should include a liberal allowance for de preciation, and sinking-fund contributions should be included with fixed charges. Sinking funds and de preciation reserves have been discussed in previous chapters.
3. Source s of dividends.—It has been said that dividends are the only unproductive expenditure which an honest and efficient corporation makes.
If the dividends exceed the net.earnings of the cur rent year, they must be paid out of the accumulated surplus. If they exceed the actual surplus, they im pair the capital of the company and are illegal, unless a reduction of capital is formally authorized by the stockholders.
If the capital has been previously impaired, current earnings may be required to restore it, and in such case are not properly available for dividends. There can be no real surplus unless the capital has been kept intact, but, where a surplus does exist, dividends may be paid out of it in the absence of special restrictions, whether dividends have been earned in the current year or not.
The surplus may be designated as undivided prof its, profit and loss, income account, or surplus income. The title used to designate surplus is unimportant, but it should never be confused with reserves or sink ing funds. The surplus of a corporation consists in the difference between its assets and its liabilities, in cluding the capital stock as a liability. Reserves and sinking funds, on the other hand, are not in the busi ness, but are amounts set aside from the business for some specific purpose, and are not available for the general uses of the corporation.