Definition
The term appropriated retained earnings refers to a portion of net income identified by management or the board of directors of a company to be set aside for a specific purpose. Appropriated retained earnings may be set aside due to a legal or contractual restriction, to fund a project or pay for an upcoming expense, or protect the working capital position of the company.
Explanation
The retained earnings of a company are the portion of net income that is not distributed to common or preferred stockholders in the form of dividends, and is held by the company for future use. In large corporations, only the board of directors can appropriate retained earnings. This is normally done in accordance with a stated corporate policy. These funds are used for the following:
Working Capital: an appropriation for working capital may be declared by the board of directors, retaining funds to grow the company, rather than paying dividends.
Expected Losses: this includes anticipated negative outcomes from lawsuits and allocations of earnings to contingency funds.
Contractual Obligations: securities such as bonds may require the company to set aside a specific sum of money each year to a sinking fund.
Legal Restrictions: if a company wishes to purchase treasury stock, it may be obligated to appropriate retained earnings in an amount equal to the value of the common stock it plans to purchase.
Unappropriated retained earnings are typically paid to holders of preferred and common stock in the form of dividends.
Example
Company A wishes to expand the capacity of their production equipment at a cost of $3,000,000. The board of directors has approved an appropriation for this expansion in the amount of $1,000,000 per year for three years. The annual journal entry to record this transaction would be as follows:
Debit | Credit | |
Retained Earnings | $1,000,000 | |
Retained Earnings: Production Expansion Appropriation | $1,000,000 |
At the end of the third year, the production capacity expansion project has been completed. The special appropriation account is no longer required and can be allocated back to retained earnings.
Debit | Credit | |
Retained Earnings: Production Expansion Appropriation | $3,000,000 | |
Retained Earnings | $3,000,000 |
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorNovember 6th, 2024- The term unappropriated retained earnings refers to the net income of a company that has not been allocated by management or the board of directors to a specific purpose. Unappropriated retained earnings are usually distributed to shareholders as dividends.Moneyzine EditorSeptember 21st, 2023
- The financial accounting term working capital is used to describe the excess of current assets when compared to current liabilities. The relative size of a company's working capital is an indication of the short-term financial strength of the company.Moneyzine EditorNovember 6th, 2024
- The term self-insurance refers to a risk management approach whereby a company sets aside money to pay for certain losses. Large companies will oftentimes adopt a self-insurance approach when the risk of loss over time is thought to be less than the premiums paid to traditional insurance carriers plus the deductibles paid on claims.Moneyzine EditorNovember 6th, 2024
The term disclosing of loss contingencies refers to the reporting of potential liabilities that are both probable and can be estimated. A loss contingency is one that will be incurred by a company if a future event is triggered. Such contingencies are classified on the balance sheet as a current liability if they are both probable and can be reasonably estimated.Moneyzine EditorNovember 6th, 2024
