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The retained earnings of a
is the accumulated
of the corporation that is retained by the corporation at a particular point of time, such as at the end of the reporting period. At the end of that period, the net income (or net loss) at that point is transferred from the Profit and Loss Account to the retained earnings account. If the balance of the retained earnings account is negative it may be called accumulated losses, retained losses or accumulated deficit, or similar terminology.
Any part of a credit balance in the account can be capitalised, by the issue of , and the balance is available for distribution of
to , and the residue is carried forward into the next period. Dividends can only be paid out of the positive balance of the retained earnings account at the time that payment is to be made.
In , the retained earnings at the end of one accounting period is the opening retained earnings in the next period, to which is added the net income or net loss for that period and from which is deducted the bonus shares issued in the year and dividends paid in that period.
If a company is publicly held, the balance of retained earnings account that is negatively referred to as "accumulated deficit" may appear in the Accountant's Opinion in what is called the "Ongoing Concern" statement located at the end of required SEC financial reporting at the end of each quarter.
Retained earnings are reported in the
section of the corporation's . Corporations with net accumulated losses may refer to negative shareholders' equity as positive shareholders' deficit. A report of the movements in retained earnings are presented along with
and changes in
Due to the nature of
, retained earnings do not represent surplus cash available to a company. Rather, they represent how the company has managed its profits (i.e. whether it has distributed them as dividends or reinvested them in the business). When reinvested, those retained earnings are reflected as increases to assets (which could include cash) or reductions to liabilities on the balance sheet.
When total assets are greater than total liabilities, stockholders have a positive equity (positive ). Conversely, when total liabilities are greater than total assets, stockholders have a negative stockholders' equity (negative book value) — also sometimes called stockholders' deficit. A stockholders' deficit does not mean that stockholders owe money to the corporation as they own only its net assets and are not accountable for its , though it is one of the definitions of . It means that the value of the assets of the company must rise above its liabilities before the stockholders hold positive equity value in the company.
Retained earnings = opening retained earnings + current year net profit from p&l a/c - dividends paid in current year
A company is normally subject to a company tax on the net income of the company in a financial year. The amount added to retained earnings is generally the . In most cases in most jurisdictions no tax is payable on the accumulated earnings retained by a company. However, this creates a potential for , because the corporate tax rate is usually lower than the higher marginal rates for some individual taxpayers. Higher income taxpayers could "park" income inside a private company instead of being paid out as a dividend and then taxed at the individual rates. To remove this tax benefit, some jurisdictions impose an "" on retained earnings of private companies, usually at the highest individual marginal tax rate.
The issue of , even if funded out of retained earnings, will in most jurisdictions not be treated as a dividend distribution and not taxed in the hands of the shareholder.
Retaining earnings by a company increases the company's shareholder equity, which increases the value of each shareholder's shareholding. This increases the share price, which may result in a
liability when the shares are disposed.
The decision of whether a corporation should retain net income or have it paid out as dividends depends on several factors including, but not limited to:
Funds required for reinvestment in the corporation (called retention).
A number of factors affect the decision of the amount of profit that a corporation should retain, including:
Quantum of net profit.
Age of the business enterprise
Dividend policy of the corporation
Future plan regarding modernization and expansion.
: Hidden categories:Debt-to-Equity
Debt-to-Equity Ratio
Debt-to-Equity ratio is the ratio of total liabilities of a business to its shareholders' equity. It is a leverage ratio and it measures the degree to which the assets of the business are financed by the debts and the shareholders' equity of a business.
Debt-to-equity ratio is calculated using the following formula:
Debt-to-Equity Ratio =&Total Liabilities
Shareholders' Equity
Both total liabilities and shareholders' equity figures in the above formula can be obtained from the balance sheet of a business. A variation of the above formula uses only the interest bearing long-term liabilities in the numerator.
Lower values of debt-to-equity ratio are favorable indicating less risk. Higher debt-to-equity ratio is unfavorable because it means that the business relies more on external lenders thus it is at higher risk, especially at higher interest rates. A debt-to-equity ratio of 1.00 means that half of the assets of a business are financed by debts and half by shareholders' equity. A value higher than 1.00 means that more assets are financed by debt that those financed by money of shareholders' and vice versa.
An increasing trend in of debt-to-equity ratio is also alarming because it means that the percentage of assets of a business which are financed by the debts is increasing.
Calculate debt-to-equity ratio of a business which has total liabilities of $3,423,000 and shareholders' equity of $5,493,000.
SolutionDebt-to-Equity Ratio = $3,423,000 / $5,493,000 & 0.62
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Related Topics
Current Chapterretained earnings
Related Terms
Profits generated by a
that are not distributed to stockholders (shareholders) as dividends but are either reinvested in the
or kept as a
for specific objectives (such as to pay off a
a capital asset).
figure shown under the heading retained
is the sum of all profits retained since the company's . Retained earnings are reduced by losses, and are also called accumulated earnings, accumulated , accumulated , accumulated ,
surplus, undistributed earnings, or undivided profits. See also .
Use 'retained earnings' in a Sentence
Despite stockholder's concern, the company continued to raise their retained earnings, because they needed to complete their debt payments from the last year.
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I wanted to perform a quick calculation of the retained earnings of the company so I had to first obtain the stockholders equity.
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Some of your retained earnings should be funneled back into the business to try and generate future bigger returns for you.
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Surplus vs. Retained Earnings
by Elise Stall
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In accounting, the statement of retained earnings reports the change in a company’s retained earnings over the reporting period, breaking down changes in stockholder interest in the company and retained earnings or surplus from one accounting period to the next period. Some people use the term “surplus” when they should be using the term “retained earnings.” These two terms are occasionally misused in finance since their definitions are similar, yet not entirely identical. The proper use of each term will better reflect the company’s true financial position.
Retained Earnings Retained earnings are defined as all the profits an organization has earned since it came into existence, minus dividends paid to shareholders. Shareholders can reinvest retained earnings back into the business. When they are reinvested, stockholders can estimate how effective the investments will be by how much the organization grows. Retained earnings are calculated by taking the beginning net earnings and adding net income. Dividends are subtracted and any losses incurred must also be subtracted. Surplus Like retained earnings, capital surplus is a component of shareholders’ equity and is used to account for the amount an organization raises in excess of the par value of the shares. The par value is the stated value or face value of the shares. Shares issued and paid plus capital surplus are defined as the total amount actually paid by investors for the issued shares. Shares that have no par value generally do not have any capital surplus, and therefore all funds from shares issued are credited to common stock issued. Differentiation Both retained earnings and capital surplus represent an increase in the shareholders’ equity of an organization, but both affect it in different ways. Contributed surplus is the amount of money or assets invested in the company by shareholders, while retained earnings are the profits made by the organization but that have not yet been paid out to shareholders. Surplus can be thought of as checks shareholders are writing to the organization, while retained earnings can be thought of as the shareholders choosing to leave some of the profits with the organization rather than taking them. Financial Position Retained earnings can be used to acquire assets to generate income for the company. For example, a company may decide that investing in heavy equipment would boost production and therefore boost sales. Using funds from the retained earnings account to purchase heavy equipment would be an option so the organization can expand and grow. Retained earnings can also be used to pay outstanding debts, loans and other liabilities. When organizations use retained earnings to buy assets and pay liabilities, investors see these as favorable actions because it improves the company’s financial situation, and investors stand to earn a good return on their initial investment in future periods.
About the Author Elise Stall is an experienced writer, blogger and online entrepreneur who has been writing professionally since 2009. She currently blogs at Elise's Review. She has a Bachelor of Commerce from the University of Ontario Institute of Technology and a postgraduate diploma in small-business management from George Brown College.
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