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The retained earnings (also known as plowback) of a
corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...

corporation
is the accumulated
net income In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a busin ...
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
bonus shares Bonus Shares are stock, shares distributed by a company (law), company to its current stockholder, shareholders as fully paid shares free of charge. *to capitalise a part of the company's retained earnings *for conversion of its share premium acco ...
, and the balance is available for distribution of
dividends A dividend is a distribution of profits by a corporation A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law 'b ...
to
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s, and the residue is carried forward into the next period. Some laws, including those of most states in the United States require that dividends be only paid out of the positive balance of the retained earnings account at the time that payment is to be made. This protects creditors from a company being liquidated through dividends. A few states, however, allow payment of dividends to continue to increase a corporation’s accumulated deficit. This is known as a liquidating dividend or liquidating cash dividend. In
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, 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
shareholders' equity In finance, equity is ownership of asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce posi ...
section of the corporation's
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...

balance sheet
. 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 other comprehensive income and changes in
share capital __NOTOC__ A corporation's share capitalGlossary on Trade Financing Terms - S
in the U ...
in the
statement of changes in equity A statement of changes in equity and similarly the statement of changes in owner's equity for a , statement of changes in partners' equity for a , statement of changes in shareholders' equity for a or statement of changes in taxpayers' equity for ...
. Due to the nature of double-entry
accrual accountingAccrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabili ...
, 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.


Stockholders' equity

When total assets are greater than total liabilities, stockholders have a positive equity (positive
book value In accounting, book value is the value of an asset according to its balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances ...
). 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
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, reta ...
, though it is one of the definitions of
insolvency In accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been call ...
. 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


Tax implications

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 after tax net income. In most cases in most jurisdictions no tax is payable on the accumulated earnings retained by a company. However, this creates a potential for
tax avoidance Tax avoidance is the legal usage of the tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, inte ...
, 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 "
undistributed profits taxThe undistributed profits tax was enacted in 1936 by the United States administration of President Franklin D. Roosevelt (FDR), during the Great depression, Great Depression. The UP tax was a revenue program for FDR's New Deal. The act was controver ...
" on retained earnings of private companies, usually at the highest individual marginal tax rate. The issue of
bonus shares Bonus Shares are stock, shares distributed by a company (law), company to its current stockholder, shareholders as fully paid shares free of charge. *to capitalise a part of the company's retained earnings *for conversion of its share premium acco ...
, 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
capital gains tax A capital gains tax (CGT) is a tax on the profit realized on the sale of a non-inventory asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (t ...
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: * Tax treatment of dividends, and *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.


See also

*
Dividend coverDividend cover, also commonly known as dividend coverage, is the ratio of company's earnings (net income) over the dividend paid to shareholders, calculated as net profit or loss attributable to ordinary shareholders by total ordinary dividend. So, i ...
*
Dividend payout ratioThe dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends: :\mbox=\frac The part of earnings not paid to investors is left for investment to provide for future earnings growth. Investors seeking high curre ...
*
Liquidating dividendA liquidating distribution (or liquidating dividend) is a type of nondividend distribution made by a corporation or a partnership to its shareholder A shareholder (in the United States often referred to as stockholder) of a corporation A cor ...
*
Reserve (accounting) In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as b ...


References

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