Retained Earnings
Retained Earnings also called accumulated earnings, retained capital or earned surplus appears in the shareholder equity section of the statement of financial position more commonly known as Balance Sheet.
It is the sum of profits and losses at the end of the accounting period after deducting the amount of dividends. Retained earnings (ending balance) can be calculated by using the following formula:
Retained earnings = opening retained earnings + profit/surplus or (loss/deficit) – dividends
As the above equation shows, retained earnings is the profit reinvested in the business after paying dividends to the shareholders of the company.
Normally these funds are used to acquire non-currents assets like property, plant and equipment or to pay off a long term debt.
Non-Profit Organizations:
A non-profit organization (NPO) has the objective of serving the public or it can seek to carry out a certain mission. As the name suggests, their mission cannot simply be to earn profits like other profit-oriented organizations.
Their objective may include fulfilling the needs of the society by working on areas like religion, education, and health clubs, and wild-life preservation.
As they work for the betterment of the society, NPOs are granted tax exemptions given in most cases that they fulfill certain requirements as per the law of the country they operate in.
Another important feature of an NPO is that the profit earned by an NPO is not distributed to any owner but rather it is reinvested into the organization so that it can be used for their objective.
The profits that these organizations earn may also include donations and grants from people, other organizations, or even the government who wish to support their cause.
Retained earnings for NPO:
Due to a major difference in the objectives of a profit-oriented organization and a non-profit organization, the term accumulated funds are used instead of retained earnings, and net assets are used for equity while preparing the financial statements of the NPO.
Accumulated funds are the name of a capital fund of a non-profit organization, the amount that is added in this is a surplus resulting when the revenue generated is greater than the expenditure, and the amount that reduces this fund is a deficit which occurs when the expenditure is higher than the revenue generated.
Thus, it is an accumulation of surplus and deficits overall the years since the inception of NPO.
NPO such as clubs and societies earn from annual subscriptions paid by their members who can also sign up for life subscriptions. Life subscription is a liability and a particular amount is transferred to the income annually.
But on the death of any member, the remaining amount is credited in the capital fund.
At the commencement of a non-trading business, there is no capital fund, any surplus earned during the first year of operation establishes as the accumulation fund.
And in the following years, if there is a budgetary deficit, the accumulated fund can serve as a liquidity provider.
Example:
Following is an example in which a balance sheet of a non-profit organization is shown. It is similar to the balance sheet of a trading organization with slight changes to provide simple and not so complex calculations of the net assets.
NPO
Balance Sheet
| USD | |
| Assets | |
| Property, plant, and equipment | 200,000 |
| Cash and cash equivalents | 50,000 |
| Subscription receivables | 20,000 |
| Total Assets | 270,000 |
| Liabilities | |
| Payables | 35,000 |
| Expenses | 2,000 |
| Subscription in advance | 40,000 |
| Loan | 43,000 |
| Total Liabilities | 120,000 |
| Net Assets | 150,000 |
| Accumulated Funds | |
| Opening balance | 100,000 |
| Surplus | 50,000 |
| Closing balance | 150,000 |
In the example above the retained earnings for an NPO are calculated by adding the surplus amount which must have arisen as a result of receipts being more than the expenditure, in the opening balance.
The opening balance of the accumulated fund is the sum of profits of all the years since commencement after withdrawing any losses.
The Financial Accounting Standards Board (FASB) requires the non-profit organization to show two classes of net assets.
- Donations with restrictions
- Donations without restrictions.
Donations with restrictions:
These donations are restricted to a specific purpose or project and the organization are bound to use these funds for that specific purpose and to meet the specific expenses.
The donor may restrict the use of his donations through an agreement with the NPO. These funds are then classified separately as special funds.
Therefore, any income which is derived from this particular purpose special funds or if any profit or loss occurred from the sale of such investments will not be included in the accumulated fund but it will be credited to the special fund account.
For example, donation received for the completion of a building, funds for a clean water project.
Donations without restrictions:
These donations are not restricted and the organization may use it on any project or a purpose of their picking.
The change in net assets or accumulated funds can be calculated by using the statement of activities which works in a similar way to the income statement. It is one of the main parts of the financial statements of a non-profit organization
The revenues generated and donations received are divided between donation without restrictions and donation with restrictions and the expenses incurred in generating the income are allocated to the respective class.
The following is an example of a statement of activity
| Revenues | With restrictions | Without restrictions | Total |
| Donation | 80,000 | 100,000 | 180,000 |
| Membership | – | 500,000 | 500,000 |
| Expenses | |||
| Administrative | 20,000 | 50,000 | 70,000 |
| Operating | 40,000 | 5,000 | 45,000 |
| Change in net assets | 20,000 | 545,000 | 565,000 |
| Add opening balance | 10,000 | 300,000 | 310,000 |
| Closing balance | 30,000 | 845,000 | 875,000 |
Accumulated funds can also convert into accumulated loss if, over several periods of years, the non-profit organization faces a deficit in its statement of activities.
This states that the NPO is expending more money than it can raise through donations and receipts, this can lead to liquidity problems and is also an indicator of bankruptcy.
The organizations will then have to acquire loans to further continue the activities or they will have to cater to events that will encourage an inflow of funds in the form of donations and subscriptions.
Review by Sinra