Owners Equity - Distributed and Undistributed Profits
Q: What is the share of undistributed profits? Do we have distributed profits?
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.
Distributed and undistributed profits are also known as distributable profits
and undistributable profits
So, what are they?
Both of these accounts are known as reserves
Meaning, they are the accumulated amounts of the net profits
calculated at the end of each of the accounting periods (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 to the owners, and another that cannot be used to pay the owners (distributed).
In other words, you can withdraw money or get paid out of one of the accounts, and from the other you cannot.
At the point in time when management decide they want to pay themselves with some of the profits, they take money out of the distributable profits
The entry for this would be:Dr Distributable reserve (equity)
This entry means that the owners 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 decreases when we pay out the profits in the form of cash).
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 - especially for public companies. Check with a professional accountant to make sure you understand these.
Hope that distributed and undistributed profits make more sense now!
Michael CelenderReturn to our page of Basic Accounting Questions