Appropriated Retained Earnings

What is Appropriated Retained Earnings?

Definition: Appropriated retained earnings is a separate account from the standard retained earnings account that is used for special projects to inform shareholders of the funding issues with these projects. In other words, it’s a way to show external users the amount of money shareholders will need to contribute out of the main account in order to properly fund a special activity. You can think of this like a dedicated amount of retained earnings that are reserved for a special purpose.

Appropriated retained earnings are retained earnings that are specified by the board of directors for a particular use. Appropriated retained earnings can be used for many purposes, including acquisitions, debt reduction, stock buybacks, and R&D. There may be more than one appropriated retained earnings accounts simultaneously.

What Does Appropriated Retained Earnings Mean?

Appropriated retained earnings means retained earnings that a company’s board assigns for a distinct use, and which reduces the amount available for dividends or for other uses. The company through appropriated retained earnings accumulates earnings for a particular purpose, or ascribes it to a restrictive covenant in a loan agreement. The appropriated retained earnings are usually used for plant expansion, sinking fund, improving infrastructure, R&D, marketing, or contingencies. They are not passed on immediately to shareholders in any form. Any amount of appropriated retained earnings that are not used for such purposes will be reversed back into dividend payments. It is also called as appropriated surplus, surplus revenue, or suspense reserve.

In simple words, appropriated retained earning is the part of the retained earnings that have been approved by the Board of Directors for specific purposes including research and development, stock repurchase, reduction of debt, acquisition etc.

The company can have more than one appropriated account and different accounts will suggest the purpose of use of such earnings. The intention behind having this is that the Board clearly defines the purpose of the earnings it has retained (and not given to the shareholders as the dividend). It also shows that the company has better planning in place as it specifies the amount it will spend on various activities.

In contrast, unappropriated retained earnings are part of retained earnings that are not classified for a specific or a particular use. Although the retained earnings are specified into various accounts, however, in case there is a case for liquidation, such accounts will have no meaning and all the retained amounts will be available to be paid to the creditors or shareholders.

Appropriated retained earnings are separately reported in the equity section of the balance sheet from the normal retained earnings to inform shareholders and external users of funding needs. Many people get appropriated earnings confused with restricted retained earnings, but these two types of equity are completely different.

Restricted retained earnings are prior profits that the company is required to retain because of a law, judgment, or contract. In other words, a third party is requiring the shareholders to keep a certain amount of earnings in the company. This means that shareholders can only declare dividends to a certain amount.

Appropriated retained earnings are not bound by a contract or a law. Instead, the company and its shareholders are the ones who choice to set aside the prior profits. It’s a voluntary transfer from the main retained earnings account to the appropriated account by the company.

Example

There are many reasons why a company might decide to establish an appropriated account, but the main reason has to do with large projects. Large projects like building infrastructure, research and development, and marketing can take a large percentage of a company’s resources.

Tech companies for example invest heavily in research and development. They want to make sure their R & D programs remain healthy, so they set aside some of the company profits to make sure these programs are funded and shareholders are unable to withdrawal all of the profits from the corporation.

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:

DebitCredit
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.

DebitCredit
Retained Earnings:  Production Expansion Appropriation$3,000,000
Retained Earnings$3,000,000

List of Appropriated Retained Earnings Accounts

  • Acquisitions
  • Debt reduction
  • Research and Development
  • New construction
  • Marketing campaigns
  • Product development
  • Stock buyback
  • Reserve for future losses
  • Reserve for insurance payments/ guarantees
  • Reserve for loan/ bond covenants imposed by creditors or bondholders

Summary

  • Appropriated retained earnings are retained earnings that have been set aside by action of the board of directors for a specific use. The intent of retained earnings appropriation is to not make these funds available for payment to shareholders.
  • Appropriated retained earnings are retained earnings that are earmarked for a certain project or purpose.
  • The account is used to help third parties stay informed about the company’s agenda.
    Appropriated retained earnings accounts are used to ensure funds are kept available for a project, such as acquisitions, R&D, and buybacks, among others.
  • Funds in appropriated retained earnings account are funneled back to the retained earnings account during bankruptcy.
  • Multiple appropriated retained earnings accounts can be used.