Unappropriated Retained Earnings

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What are Unappropriated Retained Earnings?

Unappropriated Retained Earnings are the portions of the total retained earnings that have not been kept aside by the company’s board of directors to use for a specific purpose, and they are usually distributed as dividends to the shareholders of the company.

In simple terms, Unappropriated retained earnings are part of the net income the firm has no specific use outlined for it in the current time frame.

The management might have an idea of how they want to use it. They might like to work on all scenarios and simulate future cash flows before executing this idea. If it works out, it’s good, but if it does not, the management is not legally bound to disclose or implement this idea. In any case, all or part of this money can be distributed to the shareholders as dividends.

Unappropriated-Retained-Earning

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Source: Unappropriated Retained Earnings (wallstreetmojo.com)

How does Unappropriated Retained Earnings Work?

Consider an IT consulting firm – Photon, which has $ 5,000,000 of reported revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more and eventually $1,000,000 in retained earnings. The company will not automatically offer all this amount as payment to the shareholders in the form of dividends. The board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more believes that it will be in the firm’s best interest to expand and hence decided to keep $ 600,000 to reinvest in the business by buying a piece of land for its new office. Then, this $ 600,000 will be called appropriated retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more. Since there are no such plans for $ 400,000, this will be called Unappropriated retained earnings. The whole or part of this amount can be distributed to shareholders as dividends. Consider the following table:

Revenue$5,000,000.00
Expenses$4,000,000.00
Net Retained Income$1,000,000.00
Appropriated Retained Earnings$6000,000.00Purchased of Land
Unappropriated Retained Earnings$4000,000.00Can be used for Dividend Payout

Unappropriated Retained Earnings Explained in Video

 

Why is it Important for Investors?

Unappropriated retained earnings are the profits that have not been spent, nor is there a plan to do so. Since they are not directed towards a specific purpose by the board, they can be paid out as dividends. It helps determine the maximum dividend to be paid to shareholders. The greater it is, the higher the dividend that can be rewarded. Mathematically, it can be expressed as:

Dividend = max (Unappropriated retained earnings, 0)

These earnings are distributed among all the outstanding shareholders of the company and paid out as dividends per the predetermined dividend payment schedule.

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Why Unappropriated Retained Earnings Matters?

Changes in the level of unappropriated retained earnings can signal investors about the company’s plans. An increase in value, for example, could mean that the company plans to invest less in the business shortly. Though this releases the cash that shareholders could pay, this might not be the best course of action. I.e., if the company’s sector demands better machinery equipment, talent, or other assets to remain competitive.

In simple terms, the company has run out of ideas that can help it grow, and both inorganic and organic growth looks upper-capped. In such a scenario, the company might not be able to deliver a healthy growth rate. It would eventually affect the return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more and share price as investors would like to withdraw their investment and park it in companies that can offer better growth.

Exceptions

Accounting Implications

Conclusion

Both explicitly and implicitly, financial statements say a lot about the company. Unappropriated Retained earnings form an essential section of these statements as they express a lot about the management, its growth strategy, and the firm’s growth prospects. These can be important for investors if appropriately evaluated before they park their money on the firm.

This article has been a guide to what is Unappropriated Retained earnings. Here we discuss how it works and why it is crucial for investors, along with Accounting Implications and Exceptions. You can learn more about accounting from the following articles –

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