SEC Issues Revised Guidelines on the Determination of Retained Earnings Available for Dividend Declaration

On September 19, 2023 the Securities and Exchange Commission (SEC) issued Memorandum Circular No. 16 which provides revised guidelines for the determination of retained earnings available for dividend declaration.

 

 

The guidelines shall cover the determination of the availability of retained earnings for the following dividend declarations of stock corporations in line with the Revised Corporation Code (RCC):

 

    1. Cash dividends
    2. Property dividends
    3. Stock dividends

 

 

The Reconciliation of Retained Earnings under Annex “A” of the Circular shall apply to the following:

    1. Issuers of securities to the public;
    2. Stock corporation with unappropriated/ unrestricted retained earnings in excess of 100% of its paid-in capital; or
    3. A company that applies for an acknowledgement from the Commission of its dividend declaration, i.e., cash, stock or property dividends. 

 

Definitions 

    1. “Dividends” refer to “corporate profits allocated, lawfully declared by the corporation to be paid to the stockholders on demand or at a fixed time.”
    2. “Paid-in Capital” refers to “the sum of the amount paid for shares of stock issued, including the additional paid-in capital (APIC) or premium paid over the par value of such shares.”
    3. “Retained Earnings” refers to “the accumulated profits realized out of normal and continuous operations of the corporation after deducting therefrom distributions to stockholders and transfers to capital stock or other accounts[.]” In context of the circular, “the amount of Retained Earnings shall be based on its separate (‘stand-alone’) audited financial statements.”
    4. “Unappropriated/ Unrestricted Retained Earnings” refer to “the amount of accumulated profits and gains realized out of the normal and continuous operations of the corporation after deducting therefrom distributions to stockholders and transfers to capital stock or other accounts, and which is: (1) not appropriated by the Board of Directors for definite corporate expansion projects or programs; (2) not covered by a restriction for dividend declaration under a loan agreement; and (3) not required to be retained under special circumstances obtaining in the corporation, such as when there is a need for a special reserve for probable contingencies.”

 

 

 

Section 3 of the Circular discusses the prohibition on retention of surplus profits in excess of one hundred percent (100%) paid-in capital pursuant to Section 42 of the RCC. 

 

 

Stock corporations are prohibited from retaining surplus profits in excess of 100% except:

    1. When justified by definite corporate expansion projects or programs approved by the board of directors; or
    2. When the corporation is prohibited under any loan agreement with financial institutions or creditors, whether local or foreign, from declaring dividends without their consent, and such consent has not yet been secured; or
    3. When it can be clearly shown that such retention is necessary under special circumstances obtaining in the corporation, such as when there is a need for special reserve for probable contingencies.

 

 

If a stock corporation possesses excess retained earnings, its financial statements must contain description of appropriation or restriction on their retained earnings or relevant information in connection with their compliance with the above provisions under Sec. 42 of the RCC and other related financial disclosure guidance issued by the SEC.

 

 

Significantly, Section 4 of the Circular discusses what retained earnings are available for dividends. 

 

 

“Dividends, whether cash, property, or stock, shall be declared out of unrestricted retained earnings of the corporation. Accordingly, a corporation cannot declare dividends when it has zero or negative retained earnings otherwise known as Retained Earnings Deficit. For such purpose, the surplus profits or income must be a bona fide income founded upon actual earnings or profits. The existence, therefore, of surplus profits arising from the operation of corporate business is a condition precedent to the declaration of dividends.”

 

 

“Additional Paid-in Capital shall neither be declared as a dividend nor shall it be reclassified to absorb deficiency except through an organizational restructuring duly approved by the Commission.”

 

 

 

“Furthermore, the Reconciliation of Retained Earnings in accordance with this Circular shall not be used by the Real Estate Investment Trust (REIT) companies in determining the distributable income available for its shareholders. The determination of the distributable income must be in accordance with the REIT Act and its Implementing Rules and Regulations.”

 

 

“‘[A]ctual earnings or profits’ shall be the net income for the year based on the audited financial statements, adjusted for the following unrealized items:

 

    1. Equity in net income of associate/ joint venture, net of dividends declared;
    2. Unrealized foreign exchange gain, except those attributable to cash and cash equivalents;
    3. Unrealized fair value adjustment (mark-to-market gains) of financial instruments at fair value through profit or loss (FVTPL);
    4. Unrealized fair value gain of Investment Property;
    5. Deferred Tax Asset; and
    6. Other unrealized gains and adjustments that the Commission may prescribe.”

 

 

Section 5 lays down the Amendments to the Reconciliation of Retained Earnings Available for Dividend Declaration. 

 

 

“The Reconciliation of Retained Earnings Available for Dividend Declaration is amended to account for the following items:

    1. Updates in Philippine Financial Reporting Standards (PFRS), particularly PAS 19, Employee Benefits, and PFRS 16, Leases; and
    2. Financial reporting relief related to COVID-19 provided by the SEC and BSP.”

 

 

“For purposes of this Circular, the reconciling items are presented into the following categories: (a) unrealized income recognized in the Profit or Loss in the current reporting period; (b) unrealized income recognized in the Profit or Loss in prior reporting periods but realized in the current reporting period; and (c) unrealized income recognized in the Profit or Loss in prior reporting periods but reversed in the current reporting period.”

 

 

“The Reconciliation of Retained Earnings Available for Dividend Declaration shall be filed with the annual audited financial statements and shall be covered by an Auditor’s Report.” For parent companies, “the Reconciliation of Retained Earnings must also be submitted with the consolidated audited financial statements but the amount of the retained earnings presented therein shall be based on its separate (“stand-alone”) financial statements.”

 

 

The revised Reconciliation of Retained Earnings Available for Dividend Declaration, following the format prescribed under Annex “A” of the the Circular, shall become effective for audited financial statements covering periods ending 31 December 2023 and onwards, and for audited interim financial statements starting the first quarter of 2024 and thereafter.

 

 

 

The full issuance can be found here.

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