What is the difference between retained earnings appropriated and unappropriated?

The term unappropriated retained earnings refers to the net income of a company that has not been allocated by management or the board of directors to a specific purpose. Unappropriated retained earnings can also be restricted, especially if the company has both preferred and common stock. For example, the preferred stockholders can have priority over the holders of common stock. In this case, the payment of dividends from unappropriated retained earnings is also said to be restricted.

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:

DebitCreditRetained 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.

DebitCreditRetained Earnings: Production Expansion Appropriation$3,000,000 Retained Earnings $3,000,000

Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.

Appropriated retained earnings are retained earnings that have been set aside by action of the board of directors for a specific use. The intent of retained earnings appropriation is to not make these funds available for payment to shareholders. However, if a company were to liquidate or enter bankruptcy proceedings, the appropriation status of retained earnings would be irrelevant - the earnings would be available for payout to creditors and investors. Thus, an appropriation has no legal status. An appropriation of retained earnings may be for such purposes as acquisitions, debt reduction, marketing campaigns, new construction, new product development, research and development, reserves against expected insurance losses, reserves against lawsuit settlements, restrictions imposed by a loan covenant, or a stock buyback.

The board of directors can eliminate the appropriation designation at any time. For example, the board of directors of ABC International wants to set aside $10 million for the construction of a new distribution facility, which it does by voting to appropriate $10 million of retained earnings for this purpose. The $10 million is segregated in a separate appropriated retained earnings account until the construction has been completed, after which the amount in the account is returned to the main retained earnings account.

There is generally no need to appropriate retained earnings, unless management or the board of directors is trying to communicate to investors that it wants to set aside funds for purposes other than to issue them as dividends to investors. Thus, appropriation is typically used to communicate intentions to outside parties, rather than for any internal management need.

Accounting for Appropriated Retained Earnings

To appropriate retained earnings, the entry is to debit the retained earnings account and credit the appropriated retained earnings account. There may be several appropriated retained earnings accounts, if retained earnings are being reserved for multiple purposes at the same time.

Presentation of Appropriated Retained Earnings

Any retained earnings appropriation should be clearly stated either within the body of the balance sheet or in the accompanying disclosures.

What does retained earnings appropriated mean?

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