The retained earnings (also known as plowback) of a
A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and re ...
is the accumulated
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, a ...
of the corporation that is retained by the corporation at a particular point of time, such as at the end of the reporting period. At the end of that period, the net income (or net loss) at that point is transferred from the Profit and Loss Account to the retained earnings account. If the balance of the retained earnings account is negative it may be called accumulated losses, retained losses or accumulated deficit, or similar terminology.
Any part of a credit balance in the account can be capitalised, by the issue of bonus shares
, and the balance is available for distribution of dividends
A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal ow ...
s, and the residue is carried forward into the next period. Some laws, including those of most states in the United States require that dividends be only paid out of the positive balance of the retained earnings account at the time that payment is to be made. This protects creditors from a company being liquidated through dividends. A few states, however, allow payment of dividends to continue to increase a corporation’s accumulated deficit. This is known as a liquidating dividend or liquidating cash dividend.
Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
, the retained earnings at the end of one accounting period is the opening retained earnings in the next period, to which is added the net income or net loss for that period and from which is deducted the bonus shares issued in the year and dividends paid in that period.
If a company is publicly held, the balance of retained earnings account that is negatively referred to as "accumulated deficit" may appear in the Accountant's Opinion in what is called the "Ongoing Concern" statement located at the end of required SEC financial reporting at the end of each quarter.
Retained earnings are reported in the
In finance, equity is ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of the assets. For example, if someone owns a car worth $2 ...
section of the corporation's
In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
. Corporations with net accumulated losses may refer to negative shareholders' equity as positive ''shareholders' deficit''. A report of the movements in retained earnings are presented along with other comprehensive income
and changes in share capital
in the statement of changes in equity
Due to the nature of
Double-entry bookkeeping, also known as double-entry accounting, is a method of bookkeeping that relies on a two-sided accounting entry to maintain financial information. Every entry to an account requires a corresponding and opposite entry to ... accrual accounting
, retained earnings do not represent surplus cash available to a company. Rather, they represent how the company has managed its profits (i.e. whether it has distributed them as dividends or reinvested them in the business). When reinvested, those retained earnings are reflected as increases to assets (which could include cash) or reductions to liabilities on the balance sheet.
When total assets are greater than total liabilities, stockholders have a positive equity (positive book value
). Conversely, when total liabilities are greater than total assets, stockholders have a negative stockholders' equity (negative book value) — also sometimes called stockholders' deficit. A stockholders' deficit does not mean that stockholders owe money to the corporation as they own only its net assets and are not accountable for its liabilities
, though it is one of the definitions of
In accounting, insolvency is the state of being unable to pay the debts, by a person or company (debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet i ...
. It means that the value of the assets of the company must rise above its liabilities before the stockholders hold positive equity value in the company.
:Retained earnings = opening retained earnings + current year net profit from p&l a/c - dividends paid in current year
A company is normally subject to a company tax on the net income of the company in a financial year. The amount added to retained earnings is generally the after tax net income. In most cases in most jurisdictions no tax is payable on the accumulated earnings retained by a company. However, this creates a potential for
Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdi ...
, because the corporate tax rate is usually lower than the higher marginal rates for some individual taxpayers. Higher income taxpayers could "park" income inside a private company instead of being paid out as a dividend and then taxed at the individual rates. To remove this tax benefit, some jurisdictions impose an " undistributed profits tax
" on retained earnings of private companies, usually at the highest individual marginal tax rate.
The issue of bonus shares
, even if funded out of retained earnings, will in most jurisdictions not be treated as a dividend distribution and not taxed in the hands of the shareholder.
Retaining earnings by a company increases the company's shareholder equity, which increases the value of each shareholder's shareholding. This increases the share price, which may result in a
capital gains tax
A capital gains tax (CGT) is the tax on profits realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property.
Not all countries impose a c ...
liability when the shares are disposed.
The decision of whether a corporation should retain net income or have it paid out as dividends depends on several factors including, but not limited to:
* Tax treatment of dividends
*Funds required for reinvestment in the corporation (called retention).
A number of factors affect the decision of the amount of profit that a corporation should retain, including:
*Quantum of net profit.
*Age of the business enterprise
*Dividend policy of the corporation
*Future plan regarding modernization and expansion.
* Dividend cover
* Dividend payout ratio
Liquidating dividend A liquidating distribution (or liquidating dividend) is a type of nondividend distribution made by a corporation or a partnership to its shareholders during its partial or complete liquidation. Liquidating distributions are not paid solely out of th ...
* Reserve (accounting)