Earned Surplus

Earned Surplus Retained Earnings Net Income Dividends Reinvestment Equity Business Finance
Earned Surplus, also known as Retained Earnings, represents the portion of net income that is retained by a company rather than distributed to its shareholders as dividends. These retained earnings are reinvested in the business or used to pay off debt.
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Earned Surplus

Definition

Earned Surplus, more commonly referred to as Retained Earnings, is the cumulative amount of net income a company retains rather than distributing it to the shareholders in the form of dividends. These retained earnings are crucial as they can be reinvested into the company for growth, used to pay off existing debt, or reserved for future unforeseen expenditures.

Examples

  1. Reinvestment in Business: A tech company earns a net income of $1 million in a fiscal year. Instead of paying dividends to its shareholders, it decides to retain $600,000 of these earnings to invest in R&D for a new product line.

  2. Debt Repayment: A manufacturing firm with a yearly profit of $2 million may retain $1 million to pay down its long-term debt, thus reducing interest expenses and improving financial stability.

  3. Reserve Fund: A service company may retain a portion of its earnings every year to build a reserve fund for unforeseen circumstances such as economic downturns or market volatility.

Frequently Asked Questions (FAQs)

  1. What is the difference between retained earnings and earned surplus?

    • Retained earnings and earned surplus are essentially synonymous. Both refer to the portion of net income that is retained in the company instead of being paid out as dividends.

  2. How does earned surplus impact a company’s financial health?

    • A higher earned surplus can indicate financial health as it shows that a company has a cushion for tough economic times, potential investments, or acquisitions.

  3. Can earned surplus be negative?

    • Yes, earned surplus can be negative and is often referred to as an accumulated deficit. This occurs when a company has more cumulative losses and dividend payouts than net income over time.

  4. Why might a company choose to retain earnings?

    • A company might retain earnings to fund future growth, repay debt, improve financial stability, or save for future uncertainties.

  5. How are retained earnings reported in financial statements?

    • Retained earnings are reported under the shareholders’ equity section of a company’s balance sheet.
  • Net Income: The total income or profit of a company after all expenses, taxes, and costs have been deducted.
  • Dividends: A portion of a company’s earnings distributed to shareholders, typically in the form of cash or additional shares.
  • Shareholders’ Equity: Represents the owners’ claim after subtracting total liabilities from total assets.
  • Balance Sheet: A financial statement that summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time.
  • Accumulated Deficit: A negative retained earnings balance, indicating cumulative losses over profits.

Online References

Suggested Books for Further Studies

  1. “Financial Accounting” by Walter T. Harrison Jr., Charles T. Horngren
  2. “The Portable MBA in Finance and Accounting” by Theodore Grossman, John Leslie Livingstone
  3. “Principles of Financial Accounting” by Belverd E. Needles, Marian Powers, Susan V. Crosson
  4. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

Fundamentals of Earned Surplus: Business Finance Basics Quiz

### What is another term for Earned Surplus? - [ ] Gross Profit - [x] Retained Earnings - [ ] Asset Revenue - [ ] Shareholder Dividends > **Explanation:** Earned surplus is also known as retained earnings, which refers to the portion of net income retained by a company rather than distributed as dividends. ### What can retained earnings be used for? - [x] Reinvestment in the business - [x] Paying off debt - [x] Reserve for future expenditures - [ ] Only distributed as dividends > **Explanation:** Retained earnings can be used for reinvestment in the business, paying off debt, or reserved for future expenditures. They are not limited to being distributed as dividends. ### Where is Earned Surplus reported? - [ ] Income Statement - [ ] Cash Flow Statement - [x] Balance Sheet - [ ] Statement of Cash Flows > **Explanation:** Earned surplus, or retained earnings, is reported under the shareholders' equity section of the balance sheet. ### Can retained earnings be negative? - [x] Yes - [ ] No > **Explanation:** Yes, retained earnings can be negative, which is referred to as an accumulated deficit when cumulative losses and dividends paid exceed net income. ### Why might a company choose to retain earnings rather than pay them out as dividends? - [x] To fund future growth - [x] To repay debt - [x] To improve financial stability - [ ] To decrease the value of the company > **Explanation:** Companies retain earnings to fund future growth, repay debt, and improve financial stability, ensuring the long-term sustainability of the business. ### How does a high earned surplus benefit a company? - [x] Provides a financial cushion - [x] Offers resources for reinvestment - [x] Enhances ability to pay down debt - [ ] Prevents payment of dividends > **Explanation:** A high earned surplus provides a financial cushion, offers resources for reinvestment, and enhances the company's ability to pay down debt. ### What does an accumulated deficit indicate? - [ ] High profitability - [x] Cumulative losses - [ ] Strong shareholder returns - [ ] Overrated stock > **Explanation:** An accumulated deficit indicates cumulative losses over profits, showing that the company has paid out more in losses and dividends than it has earned in net income. ### Which section of the balance sheet reflects retained earnings? - [ ] Current Liabilities - [ ] Non-current Assets - [x] Shareholders' Equity - [ ] Operating Expenses > **Explanation:** Retained earnings are reflected in the shareholders' equity section of the balance sheet. ### How does retaining earnings affect dividend payments? - [ ] It eliminates them permanently. - [ ] It guarantees lower dividends. - [x] It potentially reduces dividends. - [ ] It has no impact. > **Explanation:** Retaining earnings potentially reduces dividends as some of the profits are kept within the company for reinvestment or other purposes rather than being paid out to shareholders. ### Why is the term "retained earnings" preferred over "earned surplus"? - [x] It better represents the ongoing nature of net income retention. - [ ] It simplifies financial statements. - [ ] It indicates higher profit margins. - [ ] It helps in tax evasion. > **Explanation:** The term "retained earnings" is preferred because it better represents the ongoing nature of net income retention within the company for future use or reinvestment.

Thank you for exploring the comprehensive details of earned surplus and their implications on business finance and tackling our sample exam quiz questions. Continue to build your financial knowledge!

Wednesday, August 7, 2024
Earnest Money
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Accumulated Profits (Accumulated Earnings) January 1, 1
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Illegal Dividend January 1, 1
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