Updated July 19, 2023
Definition of Appropriate Retained Earnings
Appropriate retained earnings are those earnings that have been kept aside for some specific projects and purposes like payout to creditors and investors along with some other purposes like acquisitions, debt reductions, research and development, etc., and require the action or approval of the board of directors for their use in future and these are not available for distribution to shareholders or payment to shareholders due to its intent of appropriation rather than distribution to shareholders that helps the company to gain the trust of its existing shareholders.
Every company has to keep aside certain funds in some specific accounts for the purpose of using them in case of any uncertainty it can face in the future. Shareholders of the company do not have access to these accounts. If, in the future, the company has to perform any large transaction, it can give assurance to shareholders of having funds in its special account to gain their trust in the company and retain their existence for the long future.
How Does it Work?
The company keeps aside appropriate retained earnings for some specific project or purpose. It indicates the intention of management that it can use the funds of retained earnings for some special purpose in the future for shareholders of the company. It does not form part of the internal accounting activities of the company. The law does not make it compulsory for any company to have appropriated retained earnings account. The decision to retain earnings or allocate them for specific purposes is at the discretion of management.
Examples of Appropriated Retained Earnings
- If the company is the subsidiary of any other parent company and if suppose its parent company goes into liquidation in the future. In this case, the subsidiary company has enough funds in its appropriate retained earning accounts so that it could survive on a standalone basis as a separate new company. It generally happens in the case when the subsidiary and parent have different lines of business and the subsidiary company has maintained enough funds in its appropriated retained earnings account with the plan of surviving in case of liquidation of its parent company.
- It can be used in case where company wants to acquire any new headquarters. By this, it can gain the trust of shareholders by showing its plans to them.
List of Appropriated Retained Earnings Account
- Research and development
- Development of the new product.
- Any new construction
- Acquisition of new headquarter
- Marketing campaign
- Lawsuit settlement
- Debt Reduction
- Buyback of stocks.
- Reinvestment in operations.
- Reinvestment in construction.
Some of the advantages are:
- The appropriated retained earnings help in the growth of the company. With the proper planning and funds, these accounts help the company acquire new projects. It can reinvest its funds in research and development activities, expansion, renovation, acquisition, operations, etc. Hence, it helps the company in its long-term survival.
- Appropriated retained earnings have no cost of financing, and it does not affect the internal accounting processes of the company.
- The use of appropriated retained earnings has no other costs associated with it and hence is cost-effective.
- As the use of it brings about the existence or improvement of new results, the company gains the trust of its existing shareholders, and there is less threat to existing shareholders.
- There is no legal formality regarding retained earnings. Hence no complexities are involved.
- It strengthens the financial health of the company, which helps increase its market value of shares.
Appropriated Retained Earnings vs Unappropriated Retained Earnings
Below are some of the differences between Appropriated retained earnings and Unappropriated retained earnings
- The company allocates appropriated retained earnings for specific projects or purposes, while inappropriate retained earnings are not designated for any particular project or purpose; they are simply set aside for future use by the company.
- Unappropriated retained earnings are not accessible for distribution to shareholders, whereas appropriated retained earnings can potentially be distributed to shareholders. There is no such restriction of non-distribution to shareholders in the form of dividends.
The investors, including potential investors, board members, and insiders, always take a look at the bookkeeping process of the company. Its books should clearly show earnings, dividends, profits, and other amounts. If the company plans to acquire any new business or headquarters, it should keep aside the amounts in appropriated retained earnings accounts for a long time. Also, proper accounting processes like debiting of appropriated retained earnings and crediting of retained earnings must be properly looked into. In short, it depends on the financial health of the company and how much it can take aside the amount in its appropriated and Unappropriated retained earnings account.
This is a guide to Appropriate Retained Earnings. Here we also discuss the definition and how does it work? along with an example and advantages. You may also have a look at the following articles to learn more –