Treatment of Reserves and Accumulated Profits

Accumulated profit and earnings are a company’s net profits available after paying dividends. It is an accounting term related to the stockholders of a company. After clearing the dividends to the stockholders, the accumulated earnings and profit, also known as E&P, is a company’s net profit. It serves as a measure of the financial ability of an organisation to pay such cash distributors. 

This study material presents a brief discussion regarding earnings and accumulated profits along with the calculation method of the shareholders according to their ratio. The business infrastructure is responsible for reinvesting earnings by acquiring assets. The discussion also includes the description of debit and credit cash flow in the general reserve and assets.

Definition of Accumulated Profits

After the dividend payments are made to stockholders, the remaining profit is accumulated. It is also known as earned, undistributed, retained and reserved income. These can all refer to the same thing. It depends on the management who can choose to save it or invest it for further business growth. However, reinvestment can bring various possibilities such as:

• Expanding the business by hiring new employees, targeting new markets and customers, expanding new territories
• It can be invested in launching new products in the market; it can increase production capacity and increase the production of existing products
• It can be used on developing new marketing opportunities and market analysis
• Forming, merging, and acquiring new partnerships can also benefit a business
• It can be used in paying any existing liabilities or loans

Though the choice of management is mostly perceived as satisfactory, it can be challenged by the majority of shareholders through voting. In this case, shareholders hold the majority, as they are the company’s actual owners.

Importance of Accumulated Profits 

Accumulated profits are the retained earnings of a company in cash. This cash is distributed to the shareholders in the form of dividends. This is according to the ratio of shares an individual holds with their investments. This information is present and annually entered into the company’s balance sheet. Accumulated income is also known as reserved earning or undistributed income. After paying the dividend, if some profits remain in the company accounts, they can be reinvested or saved for business growth and future possibilities.

Calculation of Accumulated Profit in the Balance Sheet

The analysis of accumulated profit in the balance sheet can be followed by employing formulas and using the software. Dividends can be distributed in stock or cash, reducing retained earnings. The formula for calculating accumulated profits is, 

Accumulated profit = earned profit beginning of the year – cash dividends- stock dividends.

For example, a company XYZ begins its accounting period, which corresponds with the beginning of the year, with 200,000 dollars earned. The company suffers a net loss of 45,000 dollars, and at the end of the year, it pays all the dividends, worth 6000 dollars, to the shareholders, then the accumulated profit will be, 

$200,000 – $45,000 – 6,000 = $149,000.

Working criteria of accumulated Earnings and Profits (E&P)

People often get mistaken in concepts to get accurate earnings and profits annually. At the time of annual calculation, the accumulated earnings and profits are the sum of earnings and profits at the beginning of the year and current earnings and profits. In this calculation, the ratio of shareholder distribution is primarily deducted. Income and loss are decided based on specific items and data of this calculation, excluding the income tax ratio from the total accumulated earnings and profits (E&P). Accumulated E & P is the standard metric to denote the capability of any industry or firm to pay the item to be distributed, specific non-deductible expense and standard income tax ratio from the total E&P.

Conclusion

Accumulated E & P is the basic concept of calculating the profit and earning ratio of the form after the complete distribution to the shareholders. This calculation holds many aspects such as tax payments, acquisition and merger, market conditions, etc. The calculation of accumulated E & P is the retained earnings in the firm’s account. It is a vital profit that can be used in the development strategies and expansion. The analysis of the accumulated earnings and profits (E & P) require the balance sheet and dividend details of the stockholder ratio in the company.