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 requires the action or approval of 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 trust of its existing shareholders.
Every company has to keep aside certain funds in some specific accounts for the purpose of using it in case of any uncertainty it can face in future. These funds cannot be used by company’s other functions that it generally carries like distribution to shareholders in the form of dividends. Retained earnings can only be used in certain special situations or for certain specific projects. Shareholders of the company do not have access to these accounts. If in future, company has to perform any large transaction, it can give assurance to shareholders of having funds in its special account in order to gain their trust on company and retain their existence for long future.
How does it Work?
Appropriate retained earnings are kept aside by the company 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 future for shareholders of the company. It does not form part of internal accounting activities of the company. The law does not make it compulsory for any company to have appropriated retained earnings account. It is maintained on the discretion of management in order to keep itself safe in case of any bankruptcy or other similar situation in can face in future.
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 future. In this case, subsidiary company has enough funds in its appropriate retained earning accounts so it was able to survive on a standalone basis as a separate new company. It generally happens in case when the subsidiary and parent has the different lines of business and 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 trust of shareholders by showing its plans to them.
List of Appropriated Retained Earnings Account
Below is the list of appropriated retained earning accounts:
- Research and development
- Development of the new product.
- Any new construction
- Acquisition of new headquarter
- Marketing campaign
- Lawsuit settlement
- Debt Reduction
- Reserve to be utilized in case of any future restriction in loans
- Reserve to be utilizes in case of any unexpected insurance losses
- 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 in acquiring 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. Hence no complexities regarding its use are involved.
- The use of appropriated retained earnings has no other costs associated to it and hence is cost effective.
- As the use of it brings about the existence or improvement of new results, company gains the trust of its existing shareholders and there is less threat of 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 in an increase in the market value of shares of the company.
Appropriated Retained Earnings vs Unappropriated Retained Earnings
The below are some of the differences between Appropriated retained earnings and Unappropriated retained earnings
- Appropriated retained earnings are set aside by the company for some specific project or purpose whereas inappropriate retained earnings are not kept for any specific purpose or project, they are just kept aside for any use in the future by the company.
- Unappropriated retained earnings are not available for distribution to shareholders whereas appropriated retained earnings can be available for distribution to shareholders. There is no such restriction of non-distribution to shareholders in form of dividends.
- It cannot be used to give the insight of the company whereas the Unappropriated retained earnings can give an insight of the company in terms of the amount distribution of dividends, etc.
The investors, including potential investors along with board members, insiders always take a look of the book keeping process of the company. Hence the company should be assured that it has done the proper book keeping along with consideration of its earnings. Its books should have a clear picture of earnings, dividends, profits, and other amounts. If the company has the plans to acquire any new business or new headquarters, it should start keeping aside the amounts in appropriated retained earnings accounts from a long time. Also, this account should be kept aside for any distribution to shareholders so that if the company gets any chance in achieving the projects along with all the permissions, it should not be stepped back due to the unavailability of funds. Also, proper accounting process 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 that 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 –