What is Appropriated Retained Earning?
Appropriated Retained Earnings is the portion out of the total retained earnings that have been kept aside by the decision of the board of directors of the company for the purpose of using them for the specific purpose as mentioned by them and thus are not available to be distributed as the dividends.
In simple words, Appropriated retained earning is the part of the retained earnings that have been approved by the Board of Directors for specific purposes including research and development, stock repurchase, reduction of debt, acquisition, etc.
The Company can have more than one appropriated account, and different accounts will suggest the purpose of the use of such earnings. The intention behind having this is that the Board clearly defines the purpose of the earnings it has retained (and not given to the shareholders as the dividend). It also shows that the Company has better planning in place as it specifies the amount it will spend on various activities.
In contrast, unappropriated retained earnings are part of retained earnings that are not classified for a specific or particular use. Although the retained earnings are specified into various accounts, however, in case there is a case for liquidation, such accounts will have no meaning, and all the retained amounts will be available to be paid to the creditors or shareholders.
List of Appropriated Retained Earnings Accounts
- Debt reduction
- Research and Development
- New construction
- Marketing campaigns
- Product development
- Stock buyback
- Reserve for future losses
- Reserve for insurance payments/ guarantees
- Reserve for loan/ bond covenants imposed by creditors or bondholders
It should be noted that the Company is not bound by a contract of a legal contract to appropriate retained earnings. It’s the prerogative of the Company to set aside the profits of the Company for various purposes. A voluntary transfer of retained earnings is done to multiple appropriated accounts.
- A pharma company spends the right amount on research and development on new medicines and cures for diseases. They would like to maintain a healthy balance sheet for research purposes. Thus, the Company may decide to appropriate a portion of retained earnings for this purpose such that the shareholders cannot withdraw all the profits. It will ensure the Company will be able to fund its research and development programs without facing liquidity/ funding crunch.
- A real estate company which is in the business of building residential and office spaces requires to purchase land and build the property. Thus, it can appropriate a portion for the purchase of such lands and may use the amount as and when the Company feels an excellent opportunity.
Let us see how the appropriate retained earnings are recorded in the financial statements. The recording does not involve setting aside cash, but only two different entries are made i.e., relevant retained earnings and unappropriated retained earnings.
The Board of Directors directs to make these separate entries.
If a company had to set aside $ 50000 from the retained earnings as a separate account for Research and development purposes, then it will debit the retained earnings account and credit the appropriated retained earnings account.
On the balance sheet, the retained earnings appropriation appears in the equity section, and it can be shown as below:
The formula to calculate retained earnings after a given financial year is:
As can be seen above, the appropriated retained earnings do not decrease the shareholders’ equity or the retained earnings but restrict the use of the amount only for the specific purpose.
However, nowadays, the formal use of appropriated earnings is decreasing. Companies mention any such amount in the footnotes to the financial statements.
For example, – Note 9. Retained earnings restrictions. According to the provisions in the loan agreement, retained earnings available for dividends are limited to $25,000.
Such footnotes appear after the formal financial statements in “Notes to Financial Statements.” The Retained Earnings account on the balance sheet would be referenced as follows: “Retained Earnings (see note 7)… $25,000″.
Is Restricted Retained Earnings the same as Appropriated Retained Earnings?
Restricted retained earnings are before retained earnings, which the Company has to keep or retain due to a contractual agreement, law, covenant. A third party requires the Company to retain some amount, and the shareholders can be distributed dividends after such an amount is retained.
Appropriated retained earnings should not be confused with the restricted retained earnings. Since Appropriated retained earnings are voluntary, and the company is not bound by a third party to retain such amounts. Also, such appropriation is not bound by contract or law, and it is on the will of the Board of Directors that such an entry is made in the balance sheet, whereas the contract bounds restricted retained earnings.
The retained earnings that the company has earmarked for a specific purpose are called appropriated retained earnings. Such appropriation is voluntary and is done by dividing the retained earnings into various headings, which denote the use for which appropriation has been made.
This article has been a guide to what is Appropriated Retained Earnings and its definition. Here we discuss the list of appropriated retained earnings along with practical examples and journal entries. You may learn more about accounting basics from the following articles –