Asked by Kendra Grady on May 12, 2024
Verified
ReGen, Inc. would like to pay a dividend to its shareholders. It has only been in business a two years and does not yet have any retained earnings. However, it has a new product, which is breaking all sales records. This quarter, it anticipates about $3 million in earned surplus. It should be able to pay all of its bills as they become due. Under which of the following tests would ReGen be able to pay a dividend? Explain each test.
a. Earned surplus test
b. Surplus test
c. Net asset test
Earned Surplus Test
A financial measure used to determine the amount of income that a company has earned and is available for dividends distribution after accounting for all necessary expenses.
Surplus Test
A financial measure used to determine if an entity has excess assets over liabilities, often in insurance contexts.
Net Asset Test
A financial metric used to evaluate a company's financial health by subtracting total liabilities from total assets.
- Understand the primary legal concerns associated with share payment transactions.
- Understand the subtleties and legal consequences of corporate payouts and shareholder duties.
Verified Answer
NK
nyaboga kiageMay 14, 2024
Final Answer :
a. No dividend could be paid under this test, because the corporation does not have any earned surplus. A profit during only one quarter does not constitute an earned surplus. Earned surplus is defined as undistributed net profits, income, gains, and losses from the date of incorporation, i.e., retained earnings. This is the most restrictive of the various tests, but it is still followed by many states.
b. It is not clear from the facts whether a dividend could be paid under this standard, but it probably could not. Surplus consists of the excess of net assets over stated capital. Surplus could consist of a capital surplus; it need not have been "earned" from the business of the corporation. Thus, this test is slightly more liberal than the earned surplus test. In all likelihood the corporation would be unable to meet this standard and would thus be unable to pay a dividend.
c. It is not clear from the facts whether a dividend could be paid under the net asset test, but as with the surplus test, it probably could not. Net assets consist of total assets minus total debts. The MBCA as amended in 1980 and the Revised Act have adopted this test. It permits dividends to be paid unless the corporation's total assets after payment of the dividend would be less than the sum of its total liabilities and the maximum amount that would then be payable for all outstanding shares having preferential rights in liquidation. Not enough information is given here to determine whether the test has been met, but the facts seem to imply that it has not.
b. It is not clear from the facts whether a dividend could be paid under this standard, but it probably could not. Surplus consists of the excess of net assets over stated capital. Surplus could consist of a capital surplus; it need not have been "earned" from the business of the corporation. Thus, this test is slightly more liberal than the earned surplus test. In all likelihood the corporation would be unable to meet this standard and would thus be unable to pay a dividend.
c. It is not clear from the facts whether a dividend could be paid under the net asset test, but as with the surplus test, it probably could not. Net assets consist of total assets minus total debts. The MBCA as amended in 1980 and the Revised Act have adopted this test. It permits dividends to be paid unless the corporation's total assets after payment of the dividend would be less than the sum of its total liabilities and the maximum amount that would then be payable for all outstanding shares having preferential rights in liquidation. Not enough information is given here to determine whether the test has been met, but the facts seem to imply that it has not.
Learning Objectives
- Understand the primary legal concerns associated with share payment transactions.
- Understand the subtleties and legal consequences of corporate payouts and shareholder duties.