Retained earnings is a financial account in which companies record accumulated net income. Each period, when a company prepares financial statements, the net income or loss impacts the value of retained earnings. Companies typically use retained earnings for various types of investment in the business or to distribute dividends to shareholders.
Restricted or appropriated retained earnings are amounts company leaders set aside for a particular purpose. When a decision is made to use available money, an entry is recorded on the company's balance sheet that debits or pulls funds from the retained earnings account and credits or moves them to a designated appropriation account. The basic purpose of this entry is to convey to owners, analysts, creditors and managers what the company intends to do with the funds.
Unlike unappropriated retained earnings, which have one basic use, appropriated earnings can go toward multiple things. Common examples of investments made with appropriated earnings are new company or asset acquisitions, debt payoffs, marketing, research and development and stock repurchases. Essentially, a company uses accumulated earnings to reinvest in the growth and development of the business. A high level of restricted earnings is usually a sign that a company is aggressively growing or trying to pay down debt.
Unappropriated retained earnings is the amount that remains in this account after all restrictions are set aside. Typically, remaining amounts are either paid to owners as dividends or held as a reserve fund for future use. According to accountant and consultant Harold Averkamp on his AccountingCoach website, a company can only legally declare dividends when it has a credit balance in the retained earnings account.
The primary reason a company restricts retained earnings is to avoid confusion or frustration on the part of owners when they don't receive dividends from appropriated earnings. Practically speaking, all balances in retained earnings accounts belong to owners until they're paid out for other purposes. In the event of a company liquidation or bankruptcy, both unappropriated and restricted earnings would be used to pay off creditors, with any remaining amounts distributed to owners.