APPROPRIATION OF RETAINED EARNINGS
Retained Earnings can be classified into unappropriated retained earnings and
appropriated retained earnings. In the absence of evidence to the contrary, the retained
earnings can be declared as dividends.
In order to limit or restrict the payment of dividends, the entity may transfer a
portion of the retained earnings unappropriated to retained earnings appropriated.
For example, company ABC has been growing at a rapid rate and needs to move into a
larger building to accommodate its workforce. The new building is going to cost them
P30,000,000 ABC can then debit their retained earnings of P30,000,000 and credit it to
appropriated retained earnings. Once the new building has been completed, ABC can
debit appropriated retained earnings and move it back over.
*The intent of retained earnings appropriation is to not make these funds available for
payment to shareholders
The appropriation of retained earnings may be described as follows:
a. Legal Appropriation
b. Contractual Appropriation
c. Voluntary or Discretionary appropriation
Legal Appropriation
Arises from the fact that the legal capital cannot be returned to the shareholders
until the entity is dissolved and liquidated. Thus, if an entity acquires its own shares, it
must have sufficient retained earnings balance, otherwise, the acquisition is illegal.
Accordingly, a portion of the retained earnings must be appropriated for an
amount equal to the cost of the treasury shares. Such appropriation is called “retained
earnings appropriated for treasury shares”
Contractual Appropriation
Arises from the fact that the terms of the bond issue and preference share issue
may impose restriction on the payment of dividends. This is to insure the eventual
payment of the bonds and redemption of the preference share.
The appropriation may be described as “retained earnings appropriated for
sinking fund or bond redemption” and “retained earnings appropriated for redemption of
preference share”.
Voluntary Appropriation
Voluntary appropriation is a matter of discretion on the part of management. This
may arise from the fact that management wishes to preserve the funds for expansion
purposes or covering possible losses or contingencies. The appropriation may be
described as follows:
a. Retained earnings appropriated for plant expansion
b. Retained earnings appropriated for increase in working capital
c. Retained earnings appropriated for contingencies
Whether legal, contractual or voluntary, the intent of the appropriation is simply to LIMIT
THE DECLARATION OF DIVIDEND.
#LoveAccounting
#TrainYourMindYourBodyWillFollow
#AkawntingNambaWan