Registered capital, a basic element of equity

Looking at the equity components, registered capital (share capital) is one of the basic elements for financing operations. If this has not been paid, it is recognised in a separate row of the balance sheet: registered capital not yet paid.

The mandatory minimum amount of registered capital is regulated by law for certain business types, while the expected size of other capital elements also has to be taken into account when it is determined. Act V of 2013 on the Hungarian Civil Code includes important requirements regarding the measures that are necessary in the case of limited liability companies when equity falls compared to the registered capital. Accordingly, a managing director must convene the members’ meeting without delay to take the necessary measures if it comes to his/her knowledge that:

• the company’s equity has fallen to half of the share capital due to a loss;
• the company’s equity has fallen below the statutory minimum amount of share capital;
• insolvency is looming over the company or it has stopped making payments;
• or the company’s assets do not cover its debts.

In these cases the members have to make a decision on making supplementary contributions, providing equity totalling the amount of share capital in another way, or decreasing the share capital. For lack of all these, a decision must be made to transform, merge or separate the company, or terminate it without a legal successor. The relevant resolutions of the members’ meeting must be carried out within three months. If this does not happen the share capital has to be decreased.

Reserves

If capital falls, the amount of any supplementary capital contribution must be recognised as an increase in the allocated reserve. Supplementary contributions are regulated in the articles of association. Supplementary contributions that are not necessary to make up for the loss have to be repaid to the members on the list of members as of the date of repayment.

Shareholders can decide to settle the capital situation by increasing the capital reserve too; in this case the registered capital has to be increased, and the Court of Registration registers the amount based on the relevant members’ resolution. The amount put into the capital reserve can later be reduced by means of a capital decrease or rearrangement, and in the case of a capital decrease it must be ensured that all capital elements fall proportionally. The amount of the capital reserve can be transferred to offset any negative retained earnings if required.

In terms of the additional equity components, retained earnings show the accumulated earnings of previous years, which, provided equity is at an appropriate level and other conditions are also fulfilled, can be distributed as a dividend and used to increase registered capital.

The valuation reserve includes the valuation difference of assets at market value (valuation reserve for upwards revaluations) and the fair value reserve. Having such a reserve always needs contribution from an audit firm.

Profit after tax

Equity includes the profit after tax of the business for the reporting year, which, if the necessary conditions are met, can be distributed as a dividend to shareholders.

It is best to define the method for financing operations along with the elements and the amounts of equity when establishing the business, and to modify these during operations in light of the options allowed by Hungarian law. Taking appropriate measures ensures an optimal composition of equity, which will comply with statutory regulations, shareholders’ interests and provide protection for lenders. Should you need an expert for planning purposes, just contact the accounting consultants of WTS Klient Hungary.

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As we already know, the Accounting Act changed as of 1 January 2016 in the sense that dividends approved by owners are not presented in the previous year’s financial statements (2016 in this case), and instead are used to reduce the retained earnings in the year the dividend decision is made. We looked in detail at the accounting aspects of these changes in an earlier article entitled “What can a dividend in Hungary be paid from?” However, the underlying legislative changes have additional impacts on disclosures in the supplementary notes and on owner decisions accepting the financial statements, and these need to be considered when opting for dividend payments.

What should you look out for when accepting financial statements? 

Resolving to pay dividends is still only possible when accepting financial statements. Yet there is no longer any need to make a statement on using the profit after tax because, irrespective of the dividend decision, this is first transferred into the retained earnings when the accounts are opened for the following year, and only on the day the dividend payment decision is made does the company reduce its accumulated profit, the retained earnings. In this respect it is no longer appropriate to speak about using year-end after-tax profit or distributing year-end profit.

 Dividend payments – what can be paid and when?

 The previous year’s unallocated retained earnings supplemented with the profit after tax can be paid out as a dividend. The previous regulation stated the exact opposite. Dividends could be paid from the reporting year’s profit after tax, and the reporting year’s profit after tax supplemented with the unallocated retained earnings. This may seem like a subtle change, but it has to be reflected in the decision accepting the financial statements.

 Recommended changes in decisions accepting financial statements

 Owing to the legislative amendments we recommend making the following changes to the wording of decisions accepting financial statements:

• We should no longer use the phrase profit or loss for the year, instead, profit after tax should be adopted as the indicator of how successful our activity is.

• It is not accurate to say that the owner decides on placing the profit after tax into the retained earnings, because this is prescribed by the Accounting Act, it is no longer subject to a decision.

• A company does not pay a dividend primarily from profit after tax. It suffices to say that the owner has decided to pay a dividend of THUF XXX. In actual fact, the dividend is paid from the retained earnings because under accounting rules any profit after tax from the previous year has to be recognised as an addition to the retained earnings on the first day of the financial year (1 January 2017), and when making a dividend decision for example on 15 May 2017 only the retained earnings has to be reduced with the dividend payment liability to the founders.
• If no decision is made by the owners as regards dividend payments, then we recommend the following wording: When accepting the financial statements the company’s owners made no decision on paying dividends.

What should be included in the notes in this respect?

Based on the Accounting Act, the supplementary notes still have to present the proposal on use of the profit after tax. This provision is somewhat contradictory to the information above and to the legal stipulation that the retained earnings can be paid as a dividend, supplemented as applicable with the previous year’s profit after tax; it is not the profit after tax that is distributed like before. We assume the legislator intended for the management’s proposal on using the profit to be presented in the financial statements, since it is the management that submits the proposal for the owner’s decision on paying a dividend.

When disclosing such information in the notes we recommend following the above approach, which means it is enough to inform the readers of the financial statements that the management proposes a dividend payment of THUF XXX. It is definitely worth adding that the management’s proposal has not yet been approved by the owner. Given that this is not a proposal on the final dividend payment, and the decision on the actual dividend is only adopted after the financial statements are prepared, the owner’s decision can deviate from the proposal. Furthermore, since the dividend is not included in the financial statements, only in the owner’s decision accepting the financial statements, having the management proposal in the financial statements could even be misleading. This is why we recommend being prudent and careful when wording any disclosures in the notes about the dividend proposal.

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From this year, the dividend is included in the annual report for the year when the decision is made

Many will likely be surprised in Hungary that this year the situation is different, and finally, because of amendments to the Accounting Act effective from 1 January 2016, any dividend must be included in the annual report for the year the decision was made, in line with IFRS rules.

The last row of the income statement of 2016 annual reports is profit after tax; the category of balance sheet profit has been cancelled. From 2016, any dividend is accounted for as of the date of the dividend decision. Thus, a dividend determined by a subsidiary or associated company in 2017 for 2016 is not included in the parent company’s 2016 annual report. The 2016 annual report does not include the amount of the dividend defined by the parent company or the owners of the company in 2017 for 2016 either.

The dividend payable will decrease the retained earnings directly when the owners become liable for payment, while any dividend received (due) will still increase income from financial transactions as of when the dividend receivable is set. In Hungary this obviously changes the calculation of the amount available for a dividend payment, i.e. the free retained earnings supplemented with the profit after tax for the previous financial year can be used for a dividend payment; the sum of any dividend received (due) not yet included in the annual report for the previous financial year but accounted for before the balance sheet preparation date (i.e. included in a resolution by the subsidiary or associated company) increases the amount.

Dividend payment limit also changed

The dividend payment limit has also changed: the retained earnings supplemented with the profit after tax for the previous financial year may only be paid as a dividend if the amount of equity less the allocated reserve and any positive valuation reserve will not fall below the registered capital after the dividend payment. Naturally, the amount of any dividend received (due) and accounted for before the balance sheet preparation date can also be included in the amount of the equity.

The new dividend calculation requirements apply to the calculation of the amount available for any interim dividend too. However, the rule that an interim dividend can only be defined and paid based on an interim balance sheet or an annual report dated no earlier than six months has not changed.

Interim dividends could only be paid in the reporting year so far, primarily because the dividend was booked back to the balance sheet date of the reporting year. However, since the dividend is included in the books as of the date of the decision, there is no legal or accounting obstacle preventing payment of an interim dividend after the end of the reporting year but before the decision on the dividend is made.

In addition to the above, the change in the accounting of a dividend also affects undercapitalisation calculations since the dividend only decreases the equity underlying the calculations from the date of the dividend decision, not from the beginning of the year.

Review and reconsider

It is worth reviewing and reconsidering the calculation of the bonuses and premiums for managers and employees if these amounts used to depend on balance sheet profit. If a company has a bank loan, it is definitely necessary to review the limits (covenants) included in the loan contract along with the required equity ratios in light of the fact that from the 2016 financial year, equity as of the balance sheet date will include any dividend received and payable with a one-year delay compared to previous years.

Article related to the topic: Guidelines for decisions on dividend payments this year

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