Profit, dividends, and appreciation;

              Bulletin HASKINS & SELLS 21
PROFITS arise from the establishment
of an enforceable right to receive an
amount in excess of cost.
Profits have been established when a
right to receive an amount in excess of cost
is represented by accounts, notes, or similar
receivables, which can be converted readily
into cash.
Profits have been realized when assets
comprehending the profit have been con­verted
into cash.
The theory that there must be something
to divide before a dividend may be de­clared,
while eminently sound, may require
some explanation. It is a condition prece­dent
to the declaration of a dividend pay­able
in cash that profits equivalent to the
proposed dividend shall have been estab­lished.
Neither business practice nor law
has required that the specific assets in
which the profits rest shall have been con­verted
into cash before the dividend can be
paid. But sound business procedure does
require that the assets which comprehend
the profits shall be on their way into cash,
and moving in that direction so sharply
that the use of a corresponding amount of
cash for the payment of the dividend
will not interfere with the prompt payment
of claims maturing in favor of current
creditors.
Dividends may be declared when profits
have been established. They may be paid
when the necessary cash can be extracted
from the business. Thus, the contro­versial
question of whether a corporation
may borrow funds with which to pay a cash
dividend, is not one of legality, but one of
business judgment and credit.
Profits, if not distributed, represent a
part of surplus. Until the profits have
been realized they must be in current as­sets,
that is, in accounts receivable, or
notes receivable, or, in some instances,
securities taken in settlement of accounts.
After realization their location is a matter
of fine-spun theory. The profits may be
in cash, or they may have been reinvested
in merchandise, plant property, securities,
or applied in the reduction of liabilities
which is equivalent to reinvestment.
Surplus is the excess of assets over lia­bilities
(including reserves) and capital.
All surplus is not profit any more than all
profit is cash. Surplus may be derived from
profit, from adjustments of asset values,
from adjustments of liabilities, or of re­serves,
or from the consideration received
in exchange for capital stock disposed of
at a premium.
Any surplus may be partitioned by
means of a stock dividend. Only earned
surplus, or surplus resulting from estab­lished
profits, may be distributed in cash.
This statement is subject to certain quali­fications.
Where surplus is derived from
the reduction of a liability, or from a re­serve
previously created out of earned
surplus, or from an apportionment of the
consideration received for capital stock
with the purpose of equalizing the rights of
shareholders to future dividends, it may
be made the basis of cash dividends.
Exception to the statement that an
increase in the value of an asset increases
surplus, is found in the case of appreciation
resulting from revaluation of depreciating
property. Such increase in value, due to
appraisal of property, frequently is found
in surplus, and frequently is described in
such cases as capital surplus. Such sur­plus
frequently is made the subject of
charge for losses resulting from operations,
or for adjustments in the value of assets
other than property.
The effect of subjecting capital surplus
to such procedure is to ignore the fact that
future depreciation of property must be
based on appraised values and that the
amount of the increase in value over cost
Profit, Dividends and Appreciation
BY JOHN R. WILDMAN