Profit on paper
Why can IFRS retained earnings full of fair value gains still be unlawful to pay out as a dividend?
Liffeyside Property Holdings DAC owns three office buildings in Dublin, prepares its individual financial statements under IFRS, and measures its investment property at fair value. After five years of rising values its statement of financial position shows retained earnings of €12.4 million. The shareholders would like a €5 million dividend. The company has the cash.
It still cannot pay it. Only €3.6 million of those retained earnings can lawfully be distributed. The rest is profit on paper: fair value gains that IFRS requires the company to recognise, but that company law does not let it hand out.
Where IFRS stops
IFRS is about measurement and disclosure for investors. It does not distinguish between realised and unrealised profits, and it says nothing about what a company may distribute. Under the fair value model, gains on investment property go through profit or loss (IAS 40.35). Gains on financial assets at fair value through profit or loss do the same (IFRS 9.5.7.1). Both end up in retained earnings, mixed in with profits that came in as cash.
The closest IFRS gets is a requirement to describe the nature and purpose of each reserve within equity (IAS 1.79(b), carried into IFRS 18 from 2027). Whether a reserve can be distributed is not an accounting question. It is a legal one.
Where company law begins
In Ireland, a company may make a distribution only out of profits available for the purpose (Companies Act 2014, s.117(1)). Those profits are its accumulated, realised profits, so far as not previously distributed or capitalised, less its accumulated, realised losses (s.117(2)). A public limited company must also pass a net assets test: after the distribution, its net assets must not be less than its called-up share capital plus undistributable reserves (s.1082).
Three details matter when the accounts are prepared under IFRS:
Losses are realised more readily than gains. For IFRS financial statements, a provision or value adjustment of any kind is treated as a realised loss (s.117(4)(b)). A fall in fair value reduces distributable profits; an equal rise usually does not increase them.
The test is applied to the relevant financial statements. Normally the last annual statements laid before the members, or interim or initial statements where needed (s.121). It is the company's own figures that count, not the group's.
Getting it wrong has consequences. A member who receives a distribution knowing, or having reasonable grounds to believe, that it was unlawful must repay it, and directors who authorise one can be liable to the company.
The UK rules are almost identical: the Companies Act 2006 sets the realised profits test in s.830 and the public company net assets test in s.831. It ties "realised" to generally accepted accounting principles at the time (s.853(4)), and the ICAEW and ICAS guidance TECH 02/17BL sets those principles out. Irish practitioners commonly use the same principles as a reference point.
What makes a profit realised
Under that guidance, a profit is realised when it arises from a transaction or event that results in qualifying consideration: cash, an asset readily convertible to cash, or the settlement or release of a liability. That turns the question into one about the asset.
Investment property: generally not readily convertible to cash. Selling a building takes months and the price is not observable at the reporting date. IAS 40 fair value gains are unrealised until the property is sold for qualifying consideration.
Listed shares in an active market: usually readily convertible. A fair value gain on a holding that could be sold at the quoted price, without the sale itself moving the price, is generally realised. This is a Level 1 measurement under IFRS 13.
Unlisted equity and Level 3 instruments: usually not readily convertible, so fair value gains are unrealised.
Gains in other comprehensive income: equity investments at fair value through OCI follow the same test. The gains never pass through profit or loss, but whether they are realised still depends on whether the shares are readily convertible to cash.
Deferred tax: deferred tax on an unrealised gain is generally treated as reducing that unrealised gain, not realised profits.
Revalued property, plant and equipment: the extra depreciation caused by a revaluation is treated as realising the revaluation gain over time (s.117(7)).
Liffeyside's numbers
Liffeyside, retained earnings at 31 Dec 2026 (€) | Amount | Realised? | Why |
Rental profits after tax, less dividends already paid | 3,200,000 | Yes | Rent received in cash |
Fair value gains on investment property, net of deferred tax (IAS 40) | 8,400,000 | No | Property is not readily convertible to cash |
Fair value gain on listed shares in an active market (IFRS 9, FVTPL) | 600,000 | Yes | Readily convertible to cash at a quoted price |
Fair value gain on an unlisted equity stake (IFRS 9, FVTPL, Level 3) | 400,000 | No | No market in which to convert it to cash |
Fair value loss on an interest rate swap | (200,000) | Realised loss | In IFRS accounts any value adjustment is a realised loss (s.117(4)(b)) |
IFRS retained earnings | 12,400,000 | ||
Profits available for distribution | 3,600,000 | 3,200,000 + 600,000 − 200,000 |
Liffeyside can pay up to €3.6 million. A €5 million dividend would include €1.4 million paid out of unrealised gains: unlawful, whatever the bank balance says.
When the gain finally becomes realised
In 2027 Liffeyside sells its Abbey Street building for €6.0 million in cash. It cost €3.5 million and has been carried at fair value, so it is sold at its carrying amount.
Sale of the Abbey Street building in 2027 (€) | IFRS profit or loss | Profits available for distribution |
Fair value gains recognised in 2022–2026 | Already in retained earnings | Unrealised |
Sold at its carrying amount of €6,000,000 for cash | No gain in 2027 | +2,500,000 becomes realised (cost €3,500,000), less tax |
IFRS profit and distributable profit move in different years. Under IFRS the gain was recognised as values rose, and the sale itself adds nothing. For company law the whole €2.5 million gain becomes realised on the sale, less the tax actually due. The year with no IFRS gain is the year the dividend capacity jumps.
Keep a separate record
Because IFRS does not separate realised from unrealised profit, the company has to. Two common approaches:
keep a memorandum analysis of retained earnings, tracking each fair value gain until it is realised; or
transfer unrealised gains each year, net of deferred tax, from retained earnings to a separate reserve within equity, such as a fair value reserve. IFRS permits transfers within equity, and the reserve's nature and purpose are then explained in the notes.
The second makes the position visible to shareholders and lenders. Either way, the analysis must be ready before the board proposes a dividend, not after.
Groups
Consolidated retained earnings are irrelevant to dividends. Each company pays out of its own realised profits in its own financial statements. A parent whose subsidiaries hold all the revalued property may have very little to distribute itself until the subsidiaries pay dividends up the group, and those subsidiaries face the same test first. Plan the order of dividends through the group before the parent's board meets.
Lawful is not the same as prudent
Passing the realised profits test is necessary, not sufficient. Directors must still consider whether the company can pay its debts after the dividend, its loan covenants and its cash needs. A company can have realised profits and still be unable to afford a distribution. And the test applies to every kind of distribution to members, not just cash dividends: a transfer of an asset at an undervalue can be a distribution too.
The audit angle
Auditors do not approve dividends, but they ask about them. They check that distributions in the year were covered by realised profits in the relevant financial statements, and when the audit report on those statements is modified, company law asks the auditor to state whether the matter is material in deciding whether a proposed distribution is lawful. Unlawful dividends are usually found after the fact, when they are hardest to unwind.
In short
IFRS measures profit. Company law decides what can be distributed. IFRS retained earnings are not the answer to "how much can we pay?"
Only accumulated realised profits less accumulated realised losses are available (s.117 CA 2014; s.830 CA 2006). PLCs also face a net assets test.
IAS 40 fair value gains and gains on unlisted or Level 3 instruments are usually unrealised. Gains on readily marketable listed shares usually are realised.
In IFRS accounts, any value adjustment is a realised loss. Gains and losses are not treated symmetrically.
Track unrealised gains separately, test each company on its own figures, and check solvency as well as the law.
Tools and templates
The Directors Kit includes "Can we pay this dividend?", a checker that works through the Companies Act tests for Ireland or the UK: the relevant financial statements, profits available for distribution and, for public companies, the net assets test. It ends with a board note for the minute book.
Related on the site:
IFRS 13 Fair Value Measurement Tool: classifies a measurement into Levels 1, 2 and 3, a useful first step in deciding whether a gain is readily convertible to cash.
Deferred tax template: the deferred tax on fair value gains, which you need for the net unrealised amount.
IAS 40 Investment Property, IFRS 9 Financial Instruments and IFRS 13 Fair Value Measurement: the Learning Hub notes.
Liffeyside Property Holdings DAC is fictional. This post explains general principles of Irish and UK company law as they interact with IFRS. It is not legal advice: the realised profits analysis and any distribution decision should be confirmed with your legal and accounting advisers. References are to the Companies Act 2014 (Ireland), the Companies Act 2006 (UK), ICAEW/ICAS TECH 02/17BL, IAS 40, IFRS 9, IFRS 13 and IAS 1.
