How to prepare a limited company appropriation

Step by step

1. Start with profit for the year. Begin with the profit after any debenture interest and tax already charged.
2. Add opening retained earnings. Bring forward the retained earnings from the previous year.
3. Deduct transfers to reserves. Subtract any amount the directors move to a general reserve.
4. Deduct dividends. Subtract the dividends paid and proposed for the year.
5. Carry forward retained earnings. The balance is the closing retained earnings shown in equity.

Worked example

Profit RM30,000 + opening RM40,000 − reserve RM5,000 − dividends RM10,000 = RM55,000 retained earnings.

Understanding the method

The income statement works out how much profit the company made. The appropriation section shows how that profit is shared out.

A company is a separate legal person owned by shareholders, so profit is dealt with formally. Some is paid out as dividends, some is set aside in reserves, and the rest stays in the company as retained earnings.

Start with profit for the year after tax. Tax comes first because it is a charge on the company before the owners have any claim. Add retained earnings brought forward, because profit that is not distributed builds up over the years.

From this total, deduct the appropriations: transfers to a general reserve, preference dividends, and ordinary dividends (interim dividends already paid, and final dividends proposed). The balance is retained earnings carried forward, which appears in equity. Think of it as an opening balance, plus this year's addition, minus payouts, equals a closing balance.

Preference dividends are usually a fixed percentage of preference share capital, so you often calculate them. Ordinary dividends may be given as an amount, a percentage of ordinary capital, or an amount per share.

First decide what each item is: profit coming in, profit brought forward, or a payout. Then place it in the standard order.

Here is an example. Profit for the year after tax is RM90,000. Retained earnings brought forward are RM35,000.

The company has RM100,000 of 6% preference shares and 200,000 ordinary shares of RM1. It paid an interim ordinary dividend of RM10,000, proposes a final dividend of RM0.05 a share, and transfers RM20,000 to general reserve.

Preference dividend: 6% × 100,000 = RM6,000. Final ordinary dividend: 200,000 × 0.05 = RM10,000. Profit plus brought forward: 90,000 + 35,000 = RM125,000.

Deductions: 20,000 + 6,000 + 10,000 + 10,000 = RM46,000. Retained earnings carried forward: 125,000 − 46,000 = RM79,000.

To check, the closing retained earnings must equal the figure shown in equity in the statement of financial position. Recalculate each dividend from its own capital base. Debenture interest is a finance cost in the income statement, above this section, because lenders are paid before owners.

Common mistakes: forgetting to add retained earnings brought forward, and treating a transfer to reserve as an expense. Another is counting a dividend twice (once as an amount and again as its per-share figure). It is a movement within equity and never touches the income statement.

If you lose marks on dividend calculations or on the order of an appropriation account, one of our teachers can rebuild one with you using past-paper figures. Book a trial class

Related skills

• How to prepare a partnership appropriation account
• How to prepare a statement of financial position
• How to record a share issue

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.