Retained Earnings

Topics: Dividend, Income statement, Generally Accepted Accounting Principles Pages: 18 (5580 words) Published: October 6, 2010

Managing a company’s operations, marketing and sales activities and expense management are but a few of the decisions that management has to deal with. After it has made a profit the company will then need to decide what to do with those profits. Among the options for using profits are: operations, returning cash to shareholders, or keeping cash in reserve for future use

Retained earnings represent the amount a company has left after it has paid all its expenses, taxes, and dividends. A company can return all the cash it has left after it has taken care of its obligations, but that would handicap its efforts to expand operations, make acquisitions, and replace equipment. Some investors like when this figure is returned to them in the form of dividends, but most do understand that something must be reinvested for the long term.

Companies may retain earnings as a strategic move; they may later spend the reserves on research and development or company acquisitions, to name a few. An example of a company that has a huge hoard of cash is Apple Inc. The company’s cash reserve of more than $40 billion is larger than the entire market capitalization of many Fortune 500 companies.

Why does Apple Inc need so much cash? In the words of Steve Jobs, the company’s CEO, "Our judgment and our instincts tell us to just leave that powder dry right where it is right now and it's going to come in awfully handy one of these days." Of course, some investors would like to see the company return some of the money to investors, whether by share buyback, which increases the value of outstanding shares, or in dividends that give investors cash. However, if the company continues to be properly managed, the strategy should bring greater shareholder value in the long term. Retained earnings are a fuzzy concept; after all you can't drop them on your foot or use them in any way. And yet retained earnings are the glue that hold your accounting reports together, if you don't maintain the integrity of the retained earnings then your balance sheet is just a piece of paper with funny marks on it. Calculating retained earnings is an intellectually simple process that is easy in concept but can cause many complications in practice. A Rose by Any Other Name

Retained earnings are accumulated earnings that have not been distributed to shareholders but rather reinvested in the business. Put simply, the net income a company earns, less the dividends it pays, is the net addition to retained earnings for the accounting period. A company's retained earnings are disclosed at or near the bottom of the shareholders equity section of the balance sheet. Accountants may prepare a separate "statement of retained earnings" that shows the change in retained earnings during the accounting period; however, the statement of retained earnings is often combined with the income statement. Retained earnings may be appropriated for specific purposes (like bond payments) or unappropriated; only unappropriated retained earnings are available to be distributed as dividends. An appropriation of retained earnings may be disclosed on the balance sheet or in the footnotes to the financial statements. Note, however, that an appropriation of retained earnings does not imply that the amount is held and segregated as cash.

The percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders' equity on the balance sheet.

The formula calculates retained earnings by adding net income to (or subtracting any net losses from) beginning retained earnings and subtracting any dividends paid to shareholders:

Also known as the "retention ratio" or "retained surplus.
In most cases, companies retain their earnings in order to invest them into areas where the company can...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Generally Accepted Accounting Principles and Earnings Cash Essay
  • Earnings before Interest and Taxes and Refer Appendix Essay
  • The Earnings Game: Everyone Plays, Nobody Wins Essay
  • Cost of Retained Earnings Research Paper
  • Generally Accepted Accounting Principles and Retained Earnings Essay
  • Earnings Management Essay
  • Earnings Management Essay

Become a StudyMode Member

Sign Up - It's Free