Appropriated Retained Earnings

Definition

The term appropriated retained earnings refers to a portion of net income identified by management or the board of directors of a company to be set aside for a specific purpose.  Appropriated retained earnings may be set aside due to a legal or contractual restriction, to fund a project or pay for an upcoming expense, or protect the working capital position of the company.

Explanation

The retained earnings of a company are the portion of net income that is not distributed to common or preferred stockholders in the form of dividends, and is held by the company for future use.  In large corporations, only the board of directors can appropriate retained earnings.  This is normally done in accordance with a stated corporate policy.  These funds are used for the following:

  • Working Capital:  an appropriation for working capital may be declared by the board of directors, retaining funds to grow the company, rather than paying dividends.
  • Expected Losses:  this includes anticipated negative outcomes from lawsuits and allocations of earnings to contingency funds.
  • Contractual Obligations:  securities such as bonds may require the company to set aside a specific sum of money each year to a sinking fund.
  • Legal Restrictions:  if a company wishes to purchase treasury stock, it may be obligated to appropriate retained earnings in an amount equal to the value of the common stock it plans to purchase.

Unappropriated retained earnings are typically paid to holders of preferred and common stock in the form of dividends.

Example

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:

  Debit Credit
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.

  Debit Credit
Retained Earnings:  Production Expansion Appropriation $3,000,000  
Retained Earnings   $3,000,000

Related Terms

balance sheet, unappropriated retained earnings, working capital, self-insurance loss contingencies