Equity - Distributed and Undistributed Profits
Q: What is the share of undistributed profits? Do we have distributed profits?
A: Yes, there is something called undistributed profits and there is also something called distributed profits. I will explain what they are below and then at the end talk briefly about the share of undistributed profits.
What are they? Well, before anything else they are profits. This would be the net profit at the end of the accounting period (year). To put it simply, at the end of the year the managers of the business decide what they want to do with the profits the business has made. One option is to create two separate accounts for the profits, one they can use to distribute the profits and another that will not be distributable. In other words, you can withdraw money from one of the accounts, and from the other you cannot. Both of these accounts are known as reserves in accounting.
At the point in time when the management decide they want to pay themselves with some of the profits, they take money out of the distributable profits account. The entry for this would be:
Dr Distributable reserve (equity)
This entry means that the equity in the form of the reserve is decreasing, and so is the bank account of the business. The entry above is basically the same as a drawings transaction, but instead of using the account "drawings" we are using the "distributable reserve" account (which is decreasing when we actually distribute the profits in the form of cash). This lesson and example of a drawings transaction is a simplified version of the entry above.
The share of undistributed profits (how much this amounts to) is up to the manager/s of the business. However, in some countries around the world there may be specific rules for certain types of business structures and especially for public companies. Check with a professional accountant to make sure you understand these.
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