Question

Explain how a corporation computes its current and accumulated Earnings & Profits balances.

Why is it necessary to distinguish between current and accumulated Earnings & Profits.

Answer 1

Explain how a corporation computes its current and accumulated Earnings & Profits balances.

As we know that current earnings / profits are different from accumulated Earnings & Profits. So a corporation will calculate both in different manner. Let’s see both one by one;

Current earnings / profits will be calculated with the help of current year revenues and expenditures. In other words we can say that when we deduct all current year business expenditures from current year revenues then we will get current earnings & profits.

Accumulated Earnings & Profits are the balanced accumulated earnings & profits of a corporation which are left after paying returns to various stakeholders. Hence we can say that after paying dividends what is left in the business is known as accumulated earnings & profits.

Thus accumulated earnings & profits will be calculated as follow;

(Beginning balance of accumulated earnings & profits + Current year profits – dividend paid in current year).

Why is it necessary to distinguish between current and accumulated Earnings & Profits?

As we have already discussed that both are different concept hence for making financial reporting better we should distinguise between current and accumulated Earnings & Profits. Apart from this it will give clear picture about a corporation to the end users. If we do not distinguish between then a corporation will not know about actual current year profits and a proper dividend policy can not be followed. Some taxation rules also required to disclosed about true current year profits hence distinguish becomes necessary.

Whether a corporation is running in profit or loss we should need to distinguish between current and accumulated Earnings & Profits because if we donot do this then inspite of being operating in loss a corporation may show surplus hence distinguish between current and accumulated Earnings & Profits should be made.