Appropriated retained earnings are retained earnings that have been set aside by action of the board of directors for a specific use. The intent of retained earnings appropriation is to not make these funds available for payment to shareholders. However, if a company were to liquidate or enter bankruptcy proceedings, the appropriation status of retained earnings would be irrelevant - the retained earnings would be available for payout to creditors and investors. Thus, an appropriation has no legal status.
An appropriation of retained earnings may be for such purposes as:
- Debt reduction
- Marketing campaigns
- New construction
- New product development
- Research and development
- Reserve against expected insurance losses
- Reserve against lawsuit settlements
- Restriction imposed by a loan covenant
- Stock buyback
To appropriate retained earnings, the entry is to debit the retained earnings account and credit the appropriated retained earnings account. There may be several appropriated retained earnings accounts, if retained earnings are being reserved for multiple purposes at the same time.
The board of directors can eliminate the appropriation designation at any time. For example, the board of directors of ABC International wants to set aside $10 million for the construction of a new distribution facility, which it does by voting to appropriate $10 million of retained earnings for this purpose. The $10 million is segregated in a separate appropriated retained earnings account until the construction has been completed, after which the amount in the account is returned to the main retained earnings account.
Any retained earnings appropriation should be clearly stated either within the body of the balance sheet or in the accompanying disclosures.
There is generally no need to appropriate retained earnings, unless management or the board of directors is trying to communicate to investors that it wants to set aside funds for purposes other than to issue them as dividends to investors. Thus, appropriation is typically used to communicate intentions to outside parties, rather than for any internal management need.