Appropriate profits between dividends and reserves

Appropriation of profits

Section 9Objective 8

Appropriation of profits

Appropriation of profits• The capital of a limited company is made of different

types of shares• The amount of shares are only increased when new

shares are issued • Net profit is not transferred to any share capital

accounts in a limited liability company• The net profit is transferred to an account known as

an appropriation ( also called statement of retained earnings or statement of owners equity account)

Appropriation of profits• The appropriation account is one of the

financial statements of a limited liability company

• The appropriation account is used for the allocation of profits and for reserves.

• The remaining profit that is not allocated is carried forward as a credit balance in the appropriation account

Appropriation of profits• The account contains the following key

components– The profit or loss for the year transferred from the

income statement– Any profits made in the past which were not

distributed ( known as retained profits or undistributed profits brought forward)

– Proposed dividends (the amount recommended by board of directors to be paid to shareholders)

Appropriation of profits– The transfer of the remaining profits to general

reserve or any other reserve– The closing balance of profits which have not been

distributed as dividends or set aside as reserves(called retained profits or undistributed profits carried forward)

Appropriation of profits

Appropriation of profits• Corporation tax is the government tax that must

be paid on the profits made by the company• Proposed dividends are the profits made by the

company which directors recommend to be paid to shareholders. This amount will be agreed by shareholders in the next Annual General Meeting (AGM)

Reserves• Two major types of reserves used by

companies to set aside funds are – capital reserves and – revenue reserves

Capital reserves• The features of capital reserves are as follows:

– Capital reserves are allocated in the appropriation account and shown in the balance sheet

– They are a part of the profits of a company which are set aside for a particular purpose

– Capital reserves are not to be used for dividend payments

– Capital reserves include » Share premium» Replacement of fixed assets» Plant expansion» Corporation tax

Revenue Reserves• The features of revenue reserves are as follows:

– Revenue reserves are amounts set aside annually from profits for any purpose decided by management

– It is required by law to set aside a revenue reserve fund– Disclosure of the fund must be stated in financial

statements– These reserves can be used for payment of dividends– Revenue reserves include

» General reserve» Profit and loss account

Appropriation account• The next slide contains an example of

appropriation account and the key components

• To label your appropriation account, the heading should contain the following information

»The name of the organisation»The name of the financial statement»The date at which it is being prepared

Appropriation account$ $

Profit for the year X

Less: transfer to general reserve

X

Proposed dividends:

Preference shares (%) X

Ordinary shares X

X

Retained profit for the year X

Add retained profits brought forward

X

Retained profit carry forward

X

Go to the next slide for the review activity

• At the beginning of the current financial year, the company has issued the following shares 300 000, 5% preference share of $1 each and 1 million ordinary shares at $1 each.

• Required:– Prepare and appropriation account

• Assume that a company has $150 000 of retained profit as an opening balance. The company made a profit of$140 000 during it current year.

• At the end of the financial year, the company’s board of directors proposed the payment of a preference share dividend and a 25% ordinary share dividend.

• The board of directors also proposed a transfer of $50 000 to a general reserve fund