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Retained earnings represents the earned capital of the reporting entity. Earned capital is the capital that develops and builds up over time from profitable operations. It consists of all undistributed income that remains invested in the reporting entity. Retained earnings (or accumulated deficit) should be stated separately on the balance sheet.

5.8.1 Restrictions on retained earnings

When a reporting entity is materially restricted from paying dividends, they should describe the restriction in the footnotes.
S-X 4-08(e) requires footnote disclosure of the following:
  • The most significant restrictions on the payment of dividends, including their sources, their pertinent provisions, and the amount of retained earnings or net income restricted or free of such restrictions
  • The amount of consolidated retained earnings that represents undistributed earnings of 50% or less-owned entities accounted for by the equity method
  • The nature of any restrictions on the ability of consolidated and unconsolidated subsidiaries to transfer funds to the parent, and the amounts of such restricted net assets
The disclosure should include not only a description of the restriction, but also a statement of the amount of retained earnings restricted or not restricted. Reporting entities should not make any statement that a portion of retained earnings is "available" for dividends because this statement ignores the possibility that it may be unwise or impractical, for business reasons, to pay a dividend. If a reporting entity chooses to make such a statement, we recommend they discuss the disclosure with legal counsel.
Figure FSP 5-2 is an example footnote disclosure of a restriction on retained earnings.
Figure FSP 5-2
Example disclosure — retained earnings restrictions
Note D — At December 31, 20X1, consolidated retained earnings was restricted in the amount of $3,500,000, representing the cost of 170,000 shares of common stock held in the treasury.

5.8.1.1 Restrictions on retained earnings in loan agreements

Loan agreements may contain restrictions on the distribution of earnings. In these circumstances, it is usually not sufficient to describe only the provisions of loan or credit agreements that restrict the amount available for dividends; the reporting entity should also state the amount restricted.
Figure FSP 5-3 is an example footnote disclosure of a restriction on retained earnings in a loan agreement.
Figure FSP 5-3
Example disclosure — restriction on retained earnings in a loan agreement
Note E — As stated more fully in the agreement, the corporation has agreed, among other things, that it will not, without the consent of the banks, declare any dividend if immediately thereafter the consolidated working capital would be less than $9 million. This working capital provision effectively limits the amount that might be paid as cash dividends to $3 million, which represents the excess of consolidated working capital.

5.8.1.2 Subsidiary restrictions on retained earnings

Reporting entities should also consider whether they should disclosure material amounts of consolidated retained earnings that are restricted because of actions by subsidiaries. Restrictions on consolidated retained earnings could, for example, arise at the subsidiary level in the following situations:
  • A domestic subsidiary with a noncontrolling interest that capitalizes retained earnings by declaring a stock dividend
  • Subsidiaries that capitalize retained earnings by transfers to common stock in order to gain tax or other advantages
  • A foreign subsidiary that is required by statute to establish a legal reserve for the protection of creditors
  • Debt covenant requirements that restrict a subsidiary’s ability to transfer funds to the parent
  • Regulated subsidiaries, such as broker dealers and insurance companies, that need to keep capital levels at certain amounts or have regulators approve dividends

5.8.2 Appropriations on retained earnings

Retained earnings may be appropriated by:
  • Actions of the board of directors (such as an authorization for the acquisition of treasury stock)
  • Arrearages of cumulative preferred stock dividends
  • Preferences of preferred stock upon involuntary liquidation in excess of par or stated value
  • Provisions in the corporate charter, loan agreements, and other contracts
ASC 505-10-45-3 permits presentation of an appropriation of retained earnings if it clearly identified within stockholders' equity on the balance sheet. A reporting entity should not transfer any part of the appropriation to net income, nor should it charge costs or losses directly to an appropriation of retained earnings.
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