Page 530 - Accounting Principles (A Business Perspective)

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Even though some refer to retained earnings appropriations as retained earnings reserves, using the term reserves
is discouraged.
Other reasons for appropriations of retained earnings include pending litigation, debt retirement, and

contingencies in general. Such appropriations do not reduce total retained earnings. They merely disclose to
balance sheet readers that a portion of retained earnings is not available for cash dividends. Thus, recording these
appropriations guarantees that the corporation limits its outflow of cash dividends while repaying a loan,
expanding a plant, or taking on some other costly endeavor. Recording retained earnings appropriations does not
involve the setting aside of cash for the indicated purpose; it merely divides retained earnings into two parts—
appropriated retained earnings and unappropriated retained earnings. The establishment of a separate fund would
require a specific directive from the board of directors. The only entry required to record the appropriation of USD

25,000 of retained earnings to fulfill the provisions in a loan agreement is:
Retained earnings (-SE) 25,000
Appropriation per loan agreement (+SE) 25,000
To record restriction on retained earnings.
When the retained earnings appropriation has served its purpose of restricting dividends and the loan has been
repaid, the board of directors may decide to return the appropriation intact to Retained Earnings. The entry to do
this is:
Appropriation per loan agreement(-SE) 25,000
Retained earnings (+SE) 25,000
To return balance in appropriation per Loan
Agreement account to Retained earnings.
On the balance sheet, retained earnings appropriations appear in the stockholders' equity section as follows:
Stockholders' equity:
Paid-in capital:
Preferred stock – 8%, $50 par value; 500 $25,000
shares authorized; issued and outstanding
Common stock - $5 par value; 10,000 50,000
shares authorized, issued and outstanding
Total paid-in capital $75,000
Retained earnings:
Appropriated:
Per loan agreement $25,000
Unappropriated 20,000
Total retained earnings 45,000
Total stockholders' equity $120,000
Note that a retained earnings appropriation does not reduce either stockholders' equity or total retained
earnings but merely earmarks (restricts) a portion of retained earnings for a specific reason.

The formal practice of recording and reporting retained earnings appropriations is decreasing. Footnote
explanations such as the following are replacing these appropriations:
Note 7. Retained earnings restrictions. According to the provisions in the loan agreement, retained earnings
available for dividends are limited to USD 20,000.
Such footnotes appear after the formal financial statements in "Notes to Financial Statements". The Retained
Earnings account on the balance sheet would be referenced as follows: "Retained Earnings (see note 7)...USD
45,000".

Changes in the composition of retained earnings reveal important information about a corporation to financial
statement users. A separate formal statement—the statement of retained earnings—discloses such changes.

Accounting Principles: A Business Perspective 531 A Global Text