Accounting for appropriated retained earnings

September 21, 2014

In this article, we’ll cover appropriation, a process by which the board of directors lets shareholders know that funds have been internally restricted.

1. Appropriation purpose and procedures

The whole point of financial statements is to satisfy the information needs of users. Stockholders are a major group of users, and it would be reasonable to expect that they would want to know if part of the retained earnings account will not be available for dividend payouts.

The board of directors has the power to designate part of retained earnings for a specific purpose. This is called appropriation. It has no real meaning to managers and other entity decision makers - it is merely used as a communication tool to let stockholders know about an internal restriction on a portion of retained earnings. It also has no real meaning in the case of an event such as bankruptcy. Appropriated retained earnings are not legally restricted, and so creditors and stockholders have full access to the funds.

The accounting procedure is simple - once the board of directors votes to appropriate a certain amount of retained earnings, the following journal entry would be made. Let’s assume that the board is setting aside funds to purchase a building next year.

Account Names

Debits

Credits

Unappropriated Retained Earnings

2,000,000

 

Appropriated Retained Earnings – Building Purchase

 

2,000,000

Once the building has been purchased, the original journal entry is reversed.

2. Balance sheet presentation

Generally, retained earnings is listed as a single shareholder’s equity account on the balance sheet. If a part of retained earnings has been appropriated, the retained earnings section will differentiate between appropriated and unappropriated amounts, followed by an aggregate amount. Note that each specific appropriation will have its own line item. For example, a company might have appropriated funds for a building purchase, debt retirement, a share repurchase plan, and a subsidiary acquisition, all at the same time. Each of those appropriations would be listed separately on the balance sheet along with unappropriated retained earnings.

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