Distributable reserves
Also written Distributable surplus
The profits a mutual fund scheme may pay out as dividend (IDCW): accrued profits, ignoring valuation gains but deducting valuation losses — so payouts come only from real, realised profit.
In plain language
A scheme's NAV includes gains on securities it still holds. Those gains are real enough for pricing units, but they are only on paper. The workbook makes the distinction sharply: accrued income is receivable and accrued expense is payable — in both cases it is only a question of time. A valuation gain is different. It may never turn into a real gain, because the securities have to be sold first.
So SEBI does not let a scheme pay dividends out of the NAV as a whole. Dividends can be paid only out of distributable reserves, calculated conservatively:
- All profits earned, on the accrual basis, are available for distribution.
- Valuation gains are ignored — but valuation losses must be adjusted against profits.
- The part of the sale price of new units that is attributable to valuation gains is not available either.
The result, in the workbook's words, ensures that dividend is paid out of real and realised profits, after providing for all possible losses.
How it works
The asymmetry is the whole design: gains must be realised to count, but losses count the moment they appear. That is prudence, and it means distributable reserves will usually be smaller than the growth in net assets.
A related account is the equalisation reserve: a certain proportion of the sale price of investments represents realised gains, and that is credited to an equalisation reserve which can also be used to pay dividends.
Once reserves exist, the declaration process is fixed:
| Step | Rule |
|---|---|
| Who decides | The trustees decide the quantum and the record date; for dividends up to monthly frequency they may delegate to AMC officials, with ratification at the next trustee board meeting |
| Public notice | The AMC issues a public communication within one day of the trustees' decision |
| Record date | Five calendar days from the issue of the notice |
| NAV | Adjusted at the end of the record date |
| Notice content | Must state that the NAV will decline by the payout and any statutory levy |
| Late payment | Interest runs on the delayed payment from the record date |
| Exemption from notice | Liquid and other debt schemes with distribution frequency from daily to monthly |
Funds must also tell investors how much of a distribution is income from appreciation of NAV and how much is capital distribution — a rule effective 1 April 2021, and the reason the option is now called Income Distribution cum Capital Withdrawal. There is no assurance of the rate or regularity of any distribution.
The formula
Distributable reserves
= Accrued interest and dividend income
+ Realised capital gains
− Realised capital losses
− Valuation (unrealised) losses
− Scheme expenses (accrued)
− Portion of sale price of new units attributable to valuation gains
(Valuation gains are NOT added.)
A worked example
A scheme with 5 crore units outstanding reports for the period (illustrative figures):
| Item | Rs crore | In NAV? | In distributable reserves? |
|---|---|---|---|
| Interest and dividend accrued | 12 | +12 | +12 |
| Realised capital gains | 5 | +5 | +5 |
| Realised capital losses | 1 | −1 | −1 |
| Valuation gains on holdings | 20 | +20 | ignored |
| Valuation losses on holdings | 4 | −4 | −4 |
| Scheme expenses | 3 | −3 | −3 |
| Total | +29 | +9 |
The period added Rs 29 crore to net assets, or Rs 5.80 per unit. But the most the trustees can distribute is Rs 9 crore, or Rs 1.80 per unit — and less still if some of the sale price of units issued during the period reflected valuation gains.
Say they declare Rs 1.50 per unit and the record date is fixed five calendar days after the notice. An investor holding 8,000 units at a cum-IDCW NAV of Rs 32.40 receives Rs 12,000, and the NAV at the end of the record date falls to about Rs 30.90. Her wealth has not grown by Rs 12,000; it has been partly handed back to her — which is why the payout must be split into income distribution and capital withdrawal.
Why NISM asks about it
Chapter 7 (Net Asset Value, Total Expense Ratio and Pricing of Units), section 7.3, sets out the distributable-reserves rules, the equalisation reserve and the record-date procedure. The chapter's sample question asks what dividends can be paid out of — distributable surplus generated by the scheme, not unit capital, premium reserve or mark-to-market profits. Expect that recall, plus a question on the treatment of valuation gains versus valuation losses, and the five-calendar-day record-date rule.
Common exam traps
- Valuation gains are ignored; valuation losses are deducted. The asymmetry is the most-tested line.
- Mark-to-market profits are not a source of dividend. Nor are unit capital or a premium reserve.
- Accrued income counts — unlike valuation gains, receiving it is "only a question of time".
- Trustees decide quantum and record date. Delegation to AMC officials is allowed only for distributions up to monthly frequency, and needs ratification.
- Record date = five calendar days from the notice; the notice itself goes out within one day of the trustees' decision.
- No notice is needed for liquid and debt schemes distributing daily to monthly.
- A distribution is not assured, even in a monthly IDCW plan — no surplus, no payout.
Where this is taught
Free preparation for NISM Series V-ARelated terms
- Record dateThe date on which a company looks at its register and decides who gets the bonus, dividend, rights or split — you must be holding the shares in your demat account at the end of that day.
- Net assetsThe unitholders' funds in a scheme: the market value of everything it owns, plus income accrued and receivables, minus what it owes to others — the figure NAV divides by the number of units.
- TrusteesThe guardians of a mutual fund trust, who hold its property for the unitholders and oversee the AMC — at least two-thirds of them independent, each approved by SEBI in advance.
- Accrual principleThe accounting rule that every expense and every income relating to a period is counted in that period whether or not it has been paid or received — so a scheme cannot show better profits by delaying payments.
- IDCWThe renamed dividend option of a mutual fund scheme — a payout that is part income and part return of your own capital, which is why the NAV falls by exactly the amount distributed.
- Equalisation reserveA component of a unit's sale price representing realised gains, set aside and usable later to pay a distribution — so part of a dividend can, in effect, be a return of the investor's own capital.
- Dividend Distribution TaxThe tax a mutual fund scheme itself deducted before paying a dividend, abolished from April 2020 — since when the payout has instead been taxed in the investor's own hands at their slab rate.
- Transfer of IDCW planA facility that automatically invests the IDCW (dividend) declared in one scheme into another scheme of the same mutual fund, on the next business day after the record date.
- Realised gainA gain a mutual fund scheme has actually banked by selling the security, as against a valuation gain, which sits in the NAV on paper and may never turn into money at all.