Definition: Accumulated earnings, also known as undistributed profits or income reserve, are profits that are not distributed to the shareholders as cash dividends and are added to the retained earnings of the firm.
What Does Accumulated Earnings Mean?
What is the definition of accumulated earnings? The accumulated earnings of a firm are profits generated, but not distributed to the shareholders as cash dividends or as corporate profit taxes. Instead, they are retained to be reinvested in a new business opportunity, to increase inventory levels, to lower long-term debt or to increase cash reserves.
On a personal level, the accumulated earnings are the undistributed corporate profits that an individual has earned without having received. Therefore, they fall into the IEBNR category of “income earned but not received” and are deducted from national income to derive the personal income.
Let’s look at an example.
Example
In a firm’s balance sheet, the retained earnings are accounted under the shareholders’ equity. In a statement of retained earnings, a firm reports the beginning balance of retained earnings, which are the undistributed profits of the previous fiscal year, the net income, the amount distributed as cash dividends to shareholders and the ending balance of retained earnings, after deducting the dividends paid.
In this example, the company ABC has a beginning balance of $3.3 billion and a net income of $2.7 million. Therefore, the total beginning balance is $6.0 billion. The dividends paid to shareholders of preferred and common stocks amount to $272.5 million. Therefore, the undistributed profits of company ABC for the fiscal year 2015 are $6.0 billion – $272.5 million = $5.7 billion. This amount of accumulated earnings can be used to lower the long-term debt or to launch a new product.
In any case, though, it should be compared to the firm’s shareholder equity. If the firm has managed to increase its shareholder equity, retaining its earnings is a good strategy.
Summary Definition
Define Accumulated Earnings: Accumulated earnings are the profits a company does not distribute to its owners and accrues year over year in the retained earnings account.
