Retained Income Overview
Retained Income is created by the company during its operation, but it is not allocated to the owner due to the needs of the company's business development or due to legal reasons, etc., and is retained in the company's profits. Retained income refers to the accumulation of the enterprise withdraws from the profits realized by previous years or retains it within the enterprise. It comes from the net profit realized by the enterprise's production and operation activities, including the enterprise's surplus reserve and undistributed profit. Among them, the surplus reserve is the cumulative surplus with a specific purpose, and the undistributed profit is the cumulative surplus without a specified purpose.
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Retained income
Profit distribution refers to the distribution of the profits that the enterprise can distribute in the year in accordance with relevant national regulations and the resolutions of investors. The profits available for distribution shall be distributed in the following order: (1) Extract the statutory surplus reserve;. (2) Withdraw statutory public welfare funds.
The profit available for distribution is minus the withdrawn statutory surplus reserves, statutory public welfare funds, etc., and the profit available for investors to distribute. Profits that can be distributed for investors shall be distributed in the following order: (1) Withdraw any surplus reserve;. (2) Dividends payable for common stocks. If there are dividends to be paid for in preferred shares, they shall be distributed before any surplus reserve is withdrawn.
Surplus reserve refers to the accumulated funds withdrawn from net profit by the enterprise in accordance with regulations, including statutory surplus reserve, arbitrary surplus reserve and statutory charity fund. The statutory surplus reserve is withdrawn at 10% of the net profit (reduce the losses of previous years) (non-company enterprises can also withdraw at a ratio of more than 10%). The accumulated statutory surplus reserve can no longer be withdrawn when the accumulated statutory surplus reserve has reached 50% of the registered capital. The arbitrary surplus reserve is mainly withdrawn by corporate enterprises in accordance with the resolutions of the shareholders' meeting, and other enterprises can also withdraw any surplus reserves as needed.
In addition to arranging the statutory surplus reserves and any surplus reserves, corporate enterprises should also withdraw statutory public welfare funds at a ratio of 5% to 10% of net profit (reducing losses from previous years). Non-company enterprises can withdraw statutory public welfare funds at a ratio not exceeding the statutory reserves.
The surplus reserve extracted by the enterprise can be used to make up for losses, increase capital (or equity), and can also be used to and issue cash dividends or profits in accordance with the prescribed conditions.
Undistributed profit refers to the profits that the net profit realized by the enterprise has been retained in the enterprise for years after making up for losses, withdrawing surplus reserves and distributing profits to investors. It is an integral part of the company's owner's equity.
Accounting of retained income
Enterprises should set up the "surplus reserve" account to account for the addition and decrease of the withdrawal and use of surplus reserves, and set up three detailed accounts under the "surplus reserves" account, "statutory surplus reserves", "arbitrary surplus reserves" and "statutory charity fund" to account for the various surplus reserves extracted from net profits by the enterprise respectively.
The undistributed profits of the enterprise should be accounted for through the "Profit Distribution" account. At the end of the year, the enterprise should transfer the net profit realized throughout the year from the "Profit this year" account to the "Profit distribution??Undistributed Profit" account, and transfer the balance of other relevant detailed accounts under the "Profit distribution" account to the "Undistributed Profit" account. After carrying forward, the credit balance of the detailed account of "Undistributed Profit" is the accumulated amount of undistributed profits. If the debit balance occurs, it indicates the accumulated unrecovered loss. Unrecovered losses can be compensated with the pre-tax profits realized in the following years, but the compensation period shall not exceed 55 years.
Comparison and enlightenment of international retained income accounting models
1. European continental retained income accounting model
In mainland Europe, in order to restrict excessive distribution of companies, many countries often legally require companies to have a certain accumulation to facilitate the company's continued operation and safeguard the interests of creditors. The provisions of retained income in continental European countries are mainly reflected in the Commercial Law and the Company Law.Usually, the "surplus reserve" is reserved in advance, that is, a certain proportion of retained income is withdrawn as the surplus reserve according to the law.
(I) German model
In Germany, the equity items on the company's balance sheet are listed below. There are four sub-items below the surplus reserves: Legal reserves, surplus reserves for own shares, regulatory surplus reserves, and other revenue reserves.
statutory surplus reserves are used to make up for losses and increase capital. This approach is similar to that of our country, but the difference is that the ratio of provisions is different. According to Article 150 of the German Shares Law, a joint-stock company shall transfer the annual surplus by 5% after deducting the losses of the previous year into the statutory surplus reserve, and the amount can reach up to 10% of the capital or at a higher proportion stipulated in the articles of association. The above provisions show that after the company makes up for the losses of the previous year, it will use 5% of the balance as the statutory surplus reserve every year, and also stipulate a 10% upper limit. Generally speaking, when the sum of the capital reserve and the statutory reserve does not exceed 10% of the share capital ratio, the statutory reserve can be used to make up for the losses of the current year or the losses of the previous year; when the sum of the capital reserve and the statutory reserve exceeds 10% of the share capital, in addition to making up for the losses, capital can also be increased.
's surplus reserve for one's own stock, the amount is the market value of "own stocks" (equivalent to the "treasure stocks" in international practice), which is mainly used to reduce or cancel the surplus reserve when one's own stock is resold, reissue, cancel, or when the value of one's own stock is adjusted to a smaller value. Regular surplus reserves are mainly those that are independently accrued in accordance with the company's regulations, or those that have a sum of the statutory surplus reserves and capital reserves exceed 10% according to the laws and regulations. Since there are two sources, it can be used by the company in accordance with its regulations or in accordance with the purposes stipulated by the statutory surplus reserve. Other surplus reserves are similar to any surplus reserves in my country. The company decides independently to make a provision ratio, mainly to stabilize the distribution of dividends and ensure that small shareholders can share a certain dividend when the company makes a profit.
(II) French model
France's regulations on retained income are similar to those of Germany. According to Article 345 of the Law on Commercial Companies No. 66-537 of July 24, 1966, stipulates that limited liability companies and joint-stock companies should withdraw at least 1/20 of the amount of money from the profits of the fiscal year of the year and subtract the amount of past losses from the past losses, which is called the statutory reserve. When the amount of reserves reaches 1/10 of the company's capital, the withdrawal of the above funds is no longer mandatory. From this provision, we can see that Germany and France have essentially the same provisions on the provision of statutory surplus reserves, and even the provision ratio is the same.
France lists the surplus reserves in its balance sheet as: statutory surplus reserves, surplus reserves (Reserves required by regulations or rules) and other (arbitrary) surplus reserves. Compared with Germany, France's surplus reserves are less "surplus reserves for its own stocks". At the same time, the notes to the French financial statements also require more detailed disclosure of the surplus reserves.
2. British and American retained income accounting model
In the British and American accounting model, the company's profit distribution is determined by the company. For retained income, there is no legal requirement for companies to withdraw statutory surplus reserves at a certain proportion, which is the biggest difference from the European continental model. The company can only be temporary for retained income that needs to be preserved for a specific purpose. When a specific purpose is achieved or no longer needed, it should be transferred back to the use of profit distribution. In the European continental model, the surplus reserves fixedly reserved by the company in a statutory proportion each year are permanent and cannot be transferred to undistributed profits.
(I) UK model
According to Article 117 of the UK Company Act: Before submitting any dividend, the board of directors may withdraw the amount they think is appropriate from the company's surplus as one or more reserves. The board of directors may freely decide to use the reserves anywhere most suitable for the use of the surplus. During the use period, the board of directors may use it in the business of the company, or in the investments (except for the shares of the company) as deemed appropriate by the board of directors. The Board may also carry forward any surplus they believe is not suitable for distribution without making it as reserve fund for the next session. The above provisions indicate that when a company needs to keep a part of the retained income for a specific purpose, the right to decide is on the company's board of directors and only when it is deemed necessary.
Since the UK does not have a statutory requirement for the provision of surplus reserves, there is no "statutory surplus reserves" item in the UK's financial reports. However, disclosure is required for reserves reserves based on the board's decision. In the UK balance sheet, it is required to disclose content such as "Reserve for own shares" and "Reserves provided for by the articles of association" and are listed in the fourth part of "Other reserves" under the "Capital and reserves". If the company does not withdraw these reserves according to the resolution of the board of directors that year, there is no need to disclose it, and it is very flexible.
(II) US model
is similar to the UK's practice, and the United States does not require the company to set aside statutory surplus reserves, and the distribution of retained income is decided by the company itself. According to US GAAP, retained income is divided into "Appropriated retained earnings" and "Unappropriated retained earnings".
In the United States, when a joint-stock company distributes retained income, it is designated for other purposes if it is not used to pay dividends and deducts from the after-tax profit for the year, it is called the distribution of retained income, or the Restrictions of retained income for restricted purposes (or designated purposes). This "other uses" include: for company stock repurchase (the "surplus reserve for their own stocks" in Germany and Britain) for internal financing of company expansion and restrictions on the company's articles of association. After the company's after-tax profits make up for losses in previous years and are used for designated purposes, what remains is the retained income that can be distributed to shareholders, that is, undistributed retained income. Article 171 of the Delaware General Corporation Law, “Special Purpose Reserve”, provides that a director may allocate a portion of the company’s funds as a reserve or reserves for dividend payments for any appropriate purpose and may be revoked for one or more reserves.
There is a special statement in the US financial report to reflect retained income, that is, the statement of retained income (The statement of retained income). This table involves the beginning, end and dividend distribution of retained earnings, but the distribution of retained earnings is not disclosed. Companies often explain the allocation of retained income in their balance sheet, generally adding brackets to indicate the amount and purpose of the allocation after the "Retained Income" item. In addition, the allocation situation is also reflected in the notes to the financial report.
3. Comparison and enlightenment of the two accounting models
(I) Comparison of the two accounting models
The system of pre-reserving surplus reserves in profit distribution is a common practice in accounting practice in mainland European countries, and it has a significant impact worldwide. For example, Italy and Japan among developed countries, Mexico and China among developing countries, have similar practices. The state compels to require the company to regularly set a fixed proportion of statutory surplus reserves in the form of laws and regulations, with the purpose of which is to promote the company to operate stably and fully protect the interests of creditors.From another perspective, this is also a manifestation of the fact that the state in the civil law system attaches importance to the government's macro-control function in economic operation.
In the British and American countries, the market economy is highly developed and fully attaches importance to the regulatory role of the "market" as the "invisible hand" on the economy. Therefore, the government rarely interferes in the specific affairs of the company. From this point of view, it is not difficult for us to understand the company's decision on the distribution of retained income between the United Kingdom and the United States. Since there is no mandatory requirement in law, the company's distribution of retained income can only be temporary rather than permanent. When a particular purpose is achieved or no longer required, it is immediately transferred from the allocated retained income to the undistributed retained income for dividends to be distributed to shareholders. This practice is mainly to protect the interests of public investors and enable investors to get timely returns.
In addition, due to different specific regulations on retained income in each country, the disclosure requirements of each country are different. In general, Germany and France have legal provisions to clearly set aside surplus reserves, and both financial reports have fixed disclosures, and both must disclose statutory surplus reserves. The United Kingdom and the United States handed over the distribution rights of retained income to the company's board of directors, so the disclosure of the distribution of retained income depends on the company's circumstances, but if there is a distribution, it must be disclosed. Britain and the United States do not require the provision of statutory surplus reserves, so naturally there is no need to disclose them.
(II) Inspiration to my country
my country's retention income system draws on the practices of developed countries: the provisions and disclosures of statutory surplus reserves are similar to those of European countries such as Germany and France, but there are still differences in specific operations. Against the backdrop of today's international accounting coordination, my country's retained income system still has something worth improving.
1. Appropriately lower the proportion and upper limit of the statutory surplus reserve. The provision ratio between Germany and France is 5%, and the upper limit is 10%; the provision ratio between my country is 10%, and the upper limit is 50%, both of which are higher than that between Germany and France. It can be seen that my country's accounting policies tend to protect the interests of the country (major shareholders). With the continuous deepening of market-oriented reform in my country, more and more small and medium-sized investors are investing in the capital market. Under such a background, my country's statutory surplus reserve system should also be appropriately revised. The author believes that the proportion and upper limit of the statutory surplus reserve should be appropriately lowered, and more profits should be distributed to the majority of investors (small and medium shareholders) so that their investments can be fully returned, so that the vital interests of small and medium investors can be protected.
2. A specific company should not be subject to the statutory surplus reserves. From a legal perspective, forcing the withdrawal of statutory surplus reserves means forcing the company to increase its own capital, reduce dividend distribution, and expand its business scale. But not all companies are suitable. For specific investment companies, fund companies, and companies that want capital exit, they do not want to increase capital, but reduce capital. For example, for a company in a sunset industry, if the company is gradually reduced in size and gradually withdrawing capital is more in line with the interests of shareholders, then the statutory surplus reserve is forced to withdraw, that is, the company needs to increase capital, which will harm the interests of shareholders. Our company law adopts a one-size-fits-all approach, and does not take into account the special requirements of these companies, narrowing the scope of application of the law. Therefore, it is recommended that the Company Law consider the special needs of these companies and make special provisions for special investment companies and fund companies so that they are not subject to the restrictions of statutory surplus reserves.
3. The statutory public welfare fund is no longer legal. According to my country's "Company Law", the company withdraws statutory public welfare funds at 5%-10% of the net profit after tax, and is used for employees' collective welfare facilities expenditures. This has a lot to do with our country's social welfare system, and the purpose is to protect the collective welfare of employees. The problem is that the statutory public welfare fund belongs to the owner's rights in nature, but must be used for the interests of employees. The two seem to be contradictory. With the development of the market economy and the establishment of the social security system, the social security of employees is borne by the government, and should not be the responsibility of the company's owner. The company's responsibility for employee benefits is mainly reflected in wages and remuneration. For example, employee housing monetization means that employee wages have begun to include the funds required for employee housing.Therefore, it is possible to consider abolishing the provisions on compulsory withdrawal of statutory public welfare funds, and no longer compulsory withdrawals from after-tax profits in a certain proportion, but the enterprise decides independently. Of course, it does not mean that companies cannot provide more benefits to employees. As long as companies are willing and capable, they can build kindergartens, welfare houses, etc. It’s just that the law does not require mandatory provisions.
The European continental model and the British and American model are the two main accounting models today, each with its own merits, and there is no absolute difference between good and bad. Different countries should adopt appropriate approaches based on their respective political and economic backgrounds. my country's retained income system should keep pace with the times based on economic development, learn from its strengths and weaknesses, so as to improve my country's accounting level as soon as possible and play a greater role in international accounting coordination.
Difference between retained income and residual income
1. The difference between the background of retained income and residual income
Remaining income is a historical concept, which refers to the accumulation of retention within the enterprise extracted or formed from the net profits achieved by enterprises over the years. According to the Company Law and the Enterprise Accounting System: When an enterprise distributes after-tax profits in accordance with the company's articles of association, on the one hand, it will withdraw the surplus reserves in accordance with the provisions of national laws, retain the profits realized in the year in the enterprise, form internal accumulation, and become an integral part of retained income; on the other hand, profits or dividends are distributed to investors, and the remaining part after the distribution of profits or dividends will be used as undistributed profits and will be distributed in the future years. This part also becomes an integral part of the company's retained income.
Remaining income (also known as economic profit) refers to the difference between the accounting profit in a certain period and the capital cost in that period, and is the income created by the enterprise that is higher than the average market return. Residual income is based on an economic perspective, which measures the surplus of the profit generated by invested capital exceeding the cost of capital. The formula is as follows: Residual income = accounting profit - capital cost = investment capital × (return on investment capital - cost of capital). The formula clearly shows that the residual income is the premium of accounting profits exceeding the opportunity cost of investment capital. Although residual income is related to accounting profits, it also has differences. It requires clearly calculating the capital cost of all the enterprise's capital (including equity and liabilities) and considering the opportunity cost of capital.
From the meaning of the two, it can be seen that retained income is a distribution of enterprise operating results under the accounting value distribution theoretical system, a capital possession state; while residual income is a net surplus of the enterprise and a net cash flow in the future under the economic value creation theoretical system. From this we can see that retained income contains a kind of accumulated value, which is the past time; while residual income reflects a kind of recreated value, which is the future time.
2. The difference between retained income and residual income constitutes content
The retained income of Chinese enterprises is specifically manifested in two parts: surplus reserve and undistributed profit. Surplus reserve refers to the accumulated funds withdrawn from net profits by the enterprise in accordance with regulations. Surplus reserves can be divided into two categories according to their purpose: statutory public welfare funds and general surplus reserves (general surplus reserves include statutory surplus reserves and arbitrary surplus reserves). The surplus reserve can be divided into three types according to its withdrawal method: one is the statutory surplus reserve, which is withdrawn at 10% of the net profit, but this reserve fund can no longer be withdrawn when it has reached 50% of the registered capital; the second is the arbitrary surplus reserve (mainly a company-based enterprise) which is withdrawn according to the resolution of the shareholders' meeting; the third is the statutory charity reserve, which is withdrawn at 5% to 10% of the net profit. The enterprise's statutory surplus reserve and any surplus reserve are mainly used to make up for losses and increase capital (or equity).
Since residual income is the present value of future cash flow from the perspective of net residual accounting, how to decompose residual income to a more basic level and make people predict based on the available corporate accounting data becomes the key to understanding the content of its composition. For example, investors may not be able to know the remaining returns in the next five years, but the sales growth rate, the company's average gross sales profit margin, asset turnover rate, and the company's usual financial leverage ratio can be obtained more reliably in the next five years.Whether we can use these lower-level but more basic ratios than residual returns to make accurate predictions of residual returns is a question worthy of our study. At present, we cannot define the content of residual returns.
3. The difference between application and evaluation of retained income and residual income
(I) The role of retained income in corporate growth
Internal accumulation is the most important source of capital for the company, followed by liabilities. The retained income, which accounts for an absolute proportion of internal accumulation, does not need to pay any costs, does not require signing some agreement with investors, and will not be affected by the securities market or other restrictions, so it is increasingly favored by corporate agents.
The accumulation rate of Chinese enterprises is relatively low, and the retained income is not enough to meet the development needs of enterprises. The long-term shortage of funds has led to excessive desire for funds for enterprises. At this stage, my country's securities market is developing very immaturely, and the issuance of bonds is strictly restricted by the Bond Management Regulations and the Company Law. However, the issuance of stocks is different. Due to the irregular dividend distribution policy, listed companies may not issue dividends or reduce the dividend payment rate, which actually causes the cost of issuing stocks to be far lower than the cost of debt capital; and once listed companies in my country collapse, there will be many means to remedy it, which causes listed companies to not be afraid of the failure of issuing new shares and affect their refinancing channels. Therefore, Chinese companies tend to issue new shares to raise equity funds to meet the growth needs of enterprises. Although equity expansion can provide financial guarantees for corporate growth, the increase in equity funds does not necessarily increase corporate growth rate. Only when an enterprise improves its own profitability, increases its own accumulation, and continuously creates value can it be the driving force for its enterprise growth.
(II) The role of residual income in corporate value evaluation
The improvement of residual income in corporate performance evaluation.
The capital asset pricing model introduced by residual income is used to determine the capital cost of the enterprise and analyze the risk characteristics of each department. The weighted average capital cost of an enterprise can be derived from the following formula: KW = DM×(1-T)×KD/(DM＋EM＋)＋EM×KE/(DM＋EM＋). Among them, DM = the market value of the total liabilities of the company; EM = the market value of the company's owner's equity; KD = the pre-tax cost of the liabilities; T = the marginal tax rate of the company; KE = the cost of the owner's equity.
Remaining income is a correction to traditional accounting profits to guide companies to accurately draw true economic returns. This correction helps solve the following problems: first, to eliminate accounting prudence; second, to eliminate or reduce the opportunity for management to manage profits; second, to protect performance measurement from past accounting measurement errors. People call the remaining income result after the above correction and adjustment as economic value added (ETVA), and the formula is: ETV = NEPAT-KWW×NA. Among them, KW is the weighted average capital cost of the enterprise; NA is the economic value of the company's assets at the beginning of the period; NCAP is based on the net operating profit of the reporting period and obtained through the following adjustments: ① plus the increase in bad debt reserves; ② plus the increase in inventory under the latter-in-first-out pricing method; ③ plus the amortization of goodwill; ④ plus the increase in net capitalized research and development expenses; ⑤ plus other operating income (including investment income) and minus business tax.
The basic idea of using the EAV indicator to measure whether the company's performance and investor value increase is: the company's investors can freely cash out the capital they invest in the company and invest it in other assets. Therefore, investors should at least receive the opportunity cost of their investment from the company. This means that the value-added income obtained by shareholders from operating profits is the opportunity cost of capital calculated based on the economic value of equity.
