Accumulated Earnings

Accumulated earnings, also known as retained earnings, are profits produced by a company that are not distributed to shareholders as dividends. Essentially, they are company earnings that are reinvested in the company or used to pay off outstanding debt. By wisely investing these accumulated retained earnings, companies can improve their position for future earnings and an improved bottom line financially. Of course, a certain amount of reinvestment of accumulated earnings is necessary in order to continue company operations; these expenditures are referred to as retention funds, because they are essential for retaining the ability to carry on normal operations.

Because shareholders do not receive immediate returns on accumulated earnings, short-term investors may fail to achieve expected profit levels. However, accumulated earnings offer the potential for higher earnings in the future; by reducing debt and investing in necessary equipment, companies can achieve better financial performance and ensure the company’s stability into the future. Most long-term investors understand the necessity for accumulated retained earnings in order to maximize future returns. Paying down debt is especially useful for the company’s overall health, since it eliminates costly interest payments while improving the company’s bottom line profitability directly.

Accumulated Earnings and Profits

The term accumulated earnings and profits refers to a company’s net profits for the year less the disbursements paid as dividends to its shareholders. This figure is used to give an accurate snapshot of the company’s current profitability; it is calculated for tax purposes as well.

Accumulated Earnings Tax

The benefits of accumulated earnings do not come without cost. Corporations who retain dividends for investment or debt reduction are subject to an additional tax, known as the accumulated earnings tax. While this tax is assessed at the lower capital gains rate, it can still represent a significant deterrent to reinvestment of company profits at times. Because investors are often required to pay dividend taxes, upon occasion an influential group of shareholders may put pressure on a company to reinvest accumulated earnings rather than distributing dividends, thus deferring their tax liability. The accumulated earnings tax is also intended to provide an incentive for companies to pay dividends, rather than constantly reinvesting profits back into the company and avoiding the tax due on such dividends.

If the company instead loses money, it may incur what are known as accumulated losses. Since losses are never distributed among shareholders directly, these losses are instead offset against accumulated earnings profits to lessen the tax burden on the corporation. Shareholders feel the effects of accumulated losses in a lessened equity value for their stocks, not through payments or fees.

Statement of Retained Earnings

Companies that reinvest accumulated earnings or pay down corporate debt with them are generally expected to include a Statement of Retained Earnings within their annual financial report. Accumulated earnings are reported as part of the Stockholder’s Equity disclosures. Investments and disbursements other than dividends are explained and any changes or irregularities are justified to the stockholders. The retained earnings balance is calculated by adding net yearly income to the retained earnings carried over from the previous year, and then subtracting any dividends paid to shareholders.