Unappropriated Retained Earnings

Unappropriated Retained Earnings are the portions of the total retained earnings that have not been kept aside by the company's board of directors to use for a specific purpose, and they are usually distributed as dividends to the shareholders of the company.

In simple terms, Unappropriated retained earnings are part of the net income the firm has no specific use outlined for it in the current time frame.

The management might have an idea of how they want to use it. They might like to work on all scenarios and simulate future cash flows before executing this idea. If it works out, it’s good, but if it does not, the management is not legally bound to disclose or implement this idea. In any case, all or part of this money can be distributed to the shareholders as dividends.

Consider an IT consulting firm - Photon, which has $ 5,000,000 of reported revenue and eventually $1,000,000 in retained earnings. The company will not automatically offer all this amount as payment to the shareholders in the form of dividends. The board of directors believes that it will be in the firm's best interest to expand and hence decided to keep $ 600,000 to reinvest in the business by buying a piece of land for its new office. Then, this $ 600,000 will be called appropriated retained earnings. Since there are no such plans for $ 400,000, this will be called Unappropriated retained earnings. The whole or part of this amount can be distributed to shareholders as dividends. Consider the following table:

Unappropriated retained earnings are the profits that have not been spent, nor is there a plan to do so. Since they are not directed towards a specific purpose by the board, they can be paid out as dividends. It helps determine the maximum dividend to be paid to shareholders. The greater it is, the higher the dividend that can be rewarded. Mathematically, it can be expressed as:

Dividend = max (Unappropriated retained earnings, 0)

These earnings are distributed among all the outstanding shareholders of the company and paid out as dividends per the predetermined dividend payment schedule.

Changes in the level of unappropriated retained earnings can signal investors about the company's plans. An increase in value, for example, could mean that the company plans to invest less in the business shortly. Though this releases the cash that shareholders could pay, this might not be the best course of action. I.e., if the company's sector demands better machinery equipment, talent, or other assets to remain competitive.

In simple terms, the company has run out of ideas that can help it grow, and both inorganic and organic growth looks upper-capped. In such a scenario, the company might not be able to deliver a healthy growth rate. It would eventually affect the return on equity and share price as investors would like to withdraw their investment and park it in companies that can offer better growth.

• It can be restrained, especially when the firm has preferred and common stock.  For example, the preferred stockholders can prioritize over the common stockholders. In this case, the payment of dividends from unappropriated retained earnings is said to be restricted.
• Practically speaking, all balances in the accounts of retained earnings belong to owners until they're paid out for other purposes. In the event of company insolvency or bankruptcy, both unappropriated and restricted earnings would be used to pay off creditors, with any remaining amounts distributed to owners.

• Unappropriated retained earnings are reported in the owner equity section of the balance sheet. These are regulated via Generally Accepted Accounting Principles. For example, if a firm's subsidiary issues dividends after the parent company have issued financial statements, then the subsidiary company should disclose via formal documentation like pro forma financials.
• It only specifies earnings but does not specify the circumstances in which they were earned. Under GAAP, companies should specify the concerning information related to earnings in the form of notes on corporate documents. For example, if they have been reduced due to the change in the accounting method, such information should be duly disclosed.

Both explicitly and implicitly, financial statements say a lot about the company. Unappropriated Retained earnings form an essential section of these statements as they express a lot about the management, its growth strategy, and the firm's growth prospects. These can be important for investors if appropriately evaluated before they park their money on the firm.

This article has been a guide to what is Unappropriated Retained earnings. Here we discuss how it works and why it is crucial for investors, along with Accounting Implications and Exceptions. You can learn more about accounting from the following articles –

• Appropriated Retained Earnings
• Interim Financial Statements
• Quality of Earnings
• Diluted EPS