Chapter # 4

Accounting for Company –

Retained Earnings

Principles of Accounting – XII

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Accounting for Company – Retained Earnings
Chapter # 4

WHAT THE EXAMINER USUALLY ASK?

 Declaration of cash and stock dividend.
 Payment of stock and cash dividend.
 Classification of reserves.
 Creation of reserves.
 Disposal of reserves.
 Statement of retained earnings.
 Multiple Choice Questions (MCQs).

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Chapter # 4
ACCOUNTING FOR COMPANY –
RETAINED EARNINGS
RETAINED EARNINGS
Retained earnings are accumulated earnings that have not been distributed to shareholders but
rather reinvested in the business. A company's retained earnings are disclosed at or near the
bottom of the shareholders equity section of the balance sheet. Accountants may prepare a
separate "statement of retained earnings" that shows the change in retained earnings during the
accounting period; however, the statement of retained earnings is often combined with the
income statement.

RESERVES AND FUNDS

RESERVE
1. It is created out of retained earnings.
2. Reserve is a voluntary provision made
out of net income.
3. Reserve is part of owner’s equity.
4. It is shown on the credit side of the
balance sheet under owner’s equity.
5. It represents a portion of profits or
liability.
FUND
1. It is created out of cash.
2. A provision is a change expense and
revenue.
3. Fund is an asset.
4. It is shown on the debit side of the
balance sheet among assets.
5. It represents on assets.

TYPES OF RESERVES
Capital reserves are the reserves that may not be distributed according
to Company Act 1985. They include share capital, share premium,
Capital Reserve: capital redemption reserve, certain unrealized profits, or any other
reserves that the company may not distribute according to some other
act or its own article of association.

Funds held in the reserve but not disclosed in the balance sheet. They
Secret Reserve:
arise when an asset is deliberately either undisclosed or undervalued.

Allowance, created by a charge against earnings, to provide for

Valuation Reserve: changes in the value of a company's assets. Examples include
accumulated depreciation and allowance for bad debts.

Amount appropriated out of earned surplus (retained earnings) for

Surplus Reserve:
future planned or unforeseen expenditure.

Liability Reserve: Liability reserve is used to reflect a known liability.

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RESERVES
Reporting on
No. Purpose Entry to Create Entry to Write Off
Balance Sheet
Nature of Reserve: Contra Assets or Valuation Reserve
1. To decrease Bad debts expense Deduction in Allowance for bad
accounts receivable (Dr.) accounts debts (Dr.)
to their realizable Allowance for bad receivable Accounts receivable
value debts (Cr.) (Cr.)
2. To accumulate Depreciation expense Deduction in Allowance for
expired cost of (Dr.) related fixed depreciation (Dr.)
fixed assets Allowance for asset Fixed asset (Cr.)
depreciation (Cr.)
Nature of Reserve: Estimated Liability
3. To recognize Income tax expense Shown as a Reserve for income tax
estimated liability (Dr.) current liability (Dr.)
Reserve for income Bank (Cr.)
tax (Cr.)
Nature of Reserve: Appropriation of Retained Earnings
4. To restrict Retained earnings Shown as a part Reserve for building
distributable profit (Dr.) of retained extension (Dr.)
for building Reserve for building earnings Retained earnings
extension extension (Cr.) (Cr.)
5. To restrict Retained earnings Shown as a part Reserve for plant
distributable profit (Dr.) of retained expansion (Dr.)
for plant expansion Reserve for plant earnings Retained earnings
expansion (Cr.) (Cr.)
6 To restrict Retained earnings Shown as a part Reserve for debenture
distributable profit (Dr.) of retained redemption (Dr.)
for debenture Reserve for debenture earnings Retained earnings
redemption redemption (Cr.) (Cr.)
7 To restrict Retained earnings Shown as a part Reserve for
distributable profit (Dr.) of retained contingencies (Dr.)
for contingencies Reserve for earnings Retained earnings
contingencies (Cr.) (Cr.)

FUNDS
Reporting on
No. Purpose Entry to Create Entry to Write Off
Balance Sheet
Nature of Reserve: Petty Cash
1. To set aside cash Petty cash fund (Dr.) Shown as a part All expenses (Dr.)
for petty expenses Bank (Cr.) of cash Petty cash fund (Cr.)
Nature of Reserve: Sinking
2. To set aside cash Sinking fund (Dr.) Shown as a part Bonds payable (Dr.)
for sinking fund Bank (Cr.) of cash Sinking fund (Cr.)

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ILLUSTRATION # 1: (Retained Earnings)

The retained earnings account on ABC Company Ltd. showed a credit balance of Rs.400,000 on
December 31, 2010. The expense and revenue summary for the year ending on that date
showed a net income of Rs.150,000 which is transferred to retained earnings account. The
company decided on December 31, 2010 as under:
(a) To declare a cash dividend of Rs.50,000 and stock dividend of Rs.40,000.
(b) To appropriate Rs.40,000 for reserve for plant expansion.
(c) To appropriate Rs.27,000 for reserve for contingencies.
(d) To establish reserve for building extension for Rs.80,000.
(e) Cash dividend paid through bank.
(f) 4,000 shares issued in settlement of stock dividend.
REQUIRED
Give entries in General Journal to give effect to the above decisions.

SOLUTION # 1:
ABC Company Ltd.
General Journal
Date Particulars P/R Debit Credit
1 Expense and revenue summary 150,000
Retained earnings 150,000
(To record the transfer of net income to the retained
earnings account)
2 Retained earnings 50,000
Cash dividend payable 50,000
(To record the declaration of cash dividend)
3 Retained earnings 40,000
Stock dividend payable 40,000
(To record the declaration of stock dividend)
4 Retained earnings 40,000
Reserve for plant expansion 40,000
(To record the reserve for plant expansion)
5 Retained earnings 27,000
Reserve for contingencies 27,000
(To record the reserve for contingencies)
6 Retained earnings 80,000
Reserve for building extension 80,000
(To record the reserve for building extension)
7 Cash dividend payable 50,000
Bank 50,000
(To record the payment of cash dividend)
8 Stock dividend payable 40,000
Ordinary shares capital (4,000 x 10) 40,000
(To record the issue of shares in settlement of stock
dividend at par)

STATEMENT OF RETAINED EARNINGS

A financial statement outlining the changes in retained earnings for a specified period. The
statement of retained earnings is prepared in accordance with generally accepted accounting
principles (GAAP). The statement of retained earnings reconciles the beginning and ending
retained earnings for the period, using information such as net income from the other financial
statements.

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Format of Statement of Retained Earnings

Name of Company
Statement of Retained Earnings
For the Period Ended ______
Retained earnings (opening balance) XXX
Add: Net income for the period XXX
Total retained earning XXX
Less: Reserves:
Reserve for contingencies XXX
Reserve for plant expansion XXX
Total reserves (XXX)
XXX
Less: Dividends:
Cash dividend XXX
Stock dividend XXX
Total dividends (XXX)
Retained earnings (ending balance) XXX

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Practice questions
Question # 1: 1994, 1995, & 1996 Regular & Private – BIEK
(a) From the viewpoint of accounting distinguish between a Reserve and a Fund.
(b) Give the necessary journal entry in skeleton form to record the creation and disposal of the
following types of reserves:-
(i) Reserve representing liabilities.
(ii) Reserve representing retained earnings.
(c) Give the necessary journal entry in skeleton form to record the creation & disposal of a fund.

Question # 2: 1998 & 1999 Regular & Private – BIEK

(a) Define reserves and funds.
(b) Differentiate between reserves and funds.
(c) Name the three types of reserves and give an example of each.
(d) Give the necessary General journal entries to record the creation and disposal of fund.

Question # 3: 2000, 2001, & 2007 Regular & Private – BIEK

(a) Distinguish between Reserve and Fund.
(b) Give one example of each of the following types of reserves mentioning also the General
Journal entries to record, creation and disposition of each:
(i) Reserves related to assets.
(ii) Reserves representing liabilities.
(iii) Reserves representing retained earnings.

Question # 4: 1997 Regular & Private – BIEK

State which of the following is liability reserve, contra account or reserve representing retained
earnings:-
(i) Allowance for bad debts.
(ii) Reserve for building extension.
(iii) Reserve for income tax.

Question # 5: 2002 Private – BIEK

The following accounts are available on the books of a company.
(i) Reserve for bad debts.
(ii) Reserve for machinery replacement.
(iii) Cash dividend payable.
(iv) Stock dividend payable.
(v) Petty cash fund.
REQUIRED
(a) Classify the above accounts into (i) Assets, (ii) Asset valuation, (iii) Liability (iv) and
Owner’s equity accounts.
(b) Give journal entries that are made for creating and disposing of the above accounts.

Question # 6: 1993 Regular & Private – BIEK

The net income of Moazzam & Co. Ltd. for the year 1992 was Rs.320,000. The company declared
a stock dividend of Rs.100,000 (at par) and appropriated Rs.75,000 for plant expansion.
REQUIRED
Give entries in the General Journal of the company to close the income summary, and to record
the stock dividend and the appropriation.

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Question # 7: 1996 Regular & Private – BIEK
The following reserves appear on the balance sheet of Adnan Company Ltd. as of Dec. 31, 1995:-
(i) Allowance for depreciation – Building Rs. 20,000
(ii) Reserve for income tax 5,000
(iii) Reserve for contingencies 10,000
REQUIRED
(i) Classify each of the above reserves into three categories:-
Valuation reserve, Liability reserve and Surplus reserve.
(ii) Give the journal entries that must have been made to create each of the three reserves.
(iii) Give the entries that will be made dispose of each of the three reserves.

Question # 8: 2001 Regular & Private – BIEK

The retained earnings account on Jawedan Company showed a credit balance of Rs.165,000 on
March 31, 2001. The expense and revenue summary for the year ending on that date showed a
net income of Rs.145,000 which is transferred to retained earnings account. The company
decided on March 31, 2001 as under:
(a) To declare a cash dividend of Rs.50,000.
(b) To appropriate Rs.20,000 for reserve for sinking fund.
(c) To appropriate Rs.15,000 for reserve for contingencies.
(d) To establish reserve for building extension for Rs.30,000.
REQUIRED
Give entries in General Journal to give effect to the above decisions.

Question # 9: 2012 Regular – BIEK

Asghar Flours Mills Ltd. Has retained earnings balance of Rs.1,240,000 on June 30, 2010 before
transfer of net income. The net income for the year was Rs.360,000. The following resolutions
were passed in annual general meeting:
i) To declare cash dividend Rs.36,000.
ii) To establish reserve for contingencies Rs.126,000.
iii) To appropriate Rs.40,000 for sinking fund.
iv) To declare stock dividend Rs.18,000.
REQUIRED:
Set up retained earnings account.

Question # 10: 2012 Private – BIEK

On June 30, 2011, the retained earnings account in the books of Indus Company Ltd. showed a
credit balance of Rs.300,000. The expense and revenue summary of the company for the year
ending on that date shows net income of Rs.550,000, which is transferred to retained earnings
account. The company’s directors decided as follows:
i) Declare cash dividend of Rs.250,000.
ii) Establish reserve for building extension in the amount of Rs.100,000.
iii) Appropriated Rs.50,000 for reserve for debenture redemption.
iv) Establish a reserve for contingencies in the amount of Rs.45,000.
REQUIRED
Prepare retained earnings account.

Question # 11: 2004 Regular & Private – BIEK

On December 31, 2003, Adnan Co. Ltd. had a credit balance of Rs.300,000. The income summary
account of the company showed a net income of Rs.295,000 which has been transferred to
retained earnings. The company made the following decisions:
(i) Cash dividend Rs.15,000.
(ii) Reserve for plant extension Rs.122,500.
(iii) Reserve for contingencies Rs.23,500.

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(iv) Reserve for income tax Rs.3,000.
REQUIRED
Prepare journal entries in the books of the company to record the above transactions.

Question # 12: 1992 Regular & Private – BIEK

The data were extracted from the balance sheet of Al-Mehran Company Limited on December
31, 1990:-
Authorized Capital:
200,000 ordinary shares of Rs.10 each Rs.2,000,000
Issued and Paid-up Capital:
100,000 ordinary shares of Rs.10 each Rs.1,000,000
Retained earnings Rs.150,000
On December 31, 1991, the income summary of the company sowed net income of Rs.300,000.
At this date the company decided as under:-
(i) To declare cash dividend of 15%.
(ii) To appropriate Rs.100,000 for plant expansion.
(iii) To appropriate Rs.50,000 for contingencies.
(iv) To appropriate Rs.50,000 for debenture redemption.
REQUIRED
(a) Give the entry in the General Journal of the company to transfer the net income to
retained earnings account.
(b) Give entries in the General Journal to give effect to the above decision of the company.
(c) Prepare partial balance sheet of the company as of December 31, 1991.

Question # 13: 2013 Private – BIEK

The following data is extracted from the balance sheet of Talha & Co. Ltd. as on December 31,
2012:
Authorized Capital: 500,000 ordinary shares of Rs.10 each. Rs.5,000,000
Issued and Paid – up Capital: 200,000 ordinary shares of Rs.10 each. Rs.2,000,000
Retained Earnings (Credit Balance): Rs.250,000
On December 31, 2012, the income summary of the company showed a net income of
Rs.750,000. The company decided as under:
i) To declare cash dividend @ 15%.
ii) To appropriate Rs.200,000 for plant expansion.
iii) To appropriate Rs.120,000 for contingencies.
iv) To appropriate Rs.180,000 for sinking fund.
REQUIRED
Prepare necessary entries in the General Journal of Talha & Co. Ltd.

Question # 14: 2010 Regular & Private – BIEK

The following balances appearing in the books of Anum Company Ltd. on December 31, 2009:
Authorized Capital:
500,000 ordinary shares @ Rs.10 each Rs.5,000,000
Issued and Paid-up Capital:
450,000 ordinary shares @ Rs.10 each Rs.4,500,000
Retained earnings Rs.255,000
On December 31, 2009 the income summary of the company showed a credit balance of
Rs.650,000. At this date the company decided as under:
(1) To declare cash dividend of Rs.0.50 per ordinary share and 10% stock dividend.
(2) To appropriate Rs.40,000 for contingencies.
REQUIRED
(a) Give the entry in the General Journal of the company to transfer the net income to
retained earnings account.

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(b) Give entry in the General Journal to give the effect to the above decisions of the Co.

Question # 15: 2013 Regular – BIEK

Ubaid Co. Ltd. has the following shares holder’s equity as shown in balance sheet as on Dec. 31,
2012:
Authorized capital 100,000 shares of Rs.10/- each Rs. 1,000,000/-
Issued and paid up capital 50,000 shares of Rs.10/- Rs. 500,000/-
Share premium Rs. 100,000/-
Reserve for building extensions Rs. 60,000/-
Reserve for contingencies Rs. 50,000/-
Retained earnings Rs. 600,000/-
During year 2012 the company’s net income Rs. 450,000/-
Following decisions were made and executed:
i) Declaration of cash dividend @ 10%.
ii) Building extension reserve increased by Rs.100,000/-.
iii) Reserve for contingencies increased upto Rs.100,000/-.
iv) Bank paid cash dividend warrants.
REQUIRED
Record the above transactions in General Journal of the company.

Question # 16: 2005 Regular & Private – BIEK

The shareholders equity of Habeeb Limited on January 1, 2004, appears as follows:
Ordinary share capital:
60,000 shares of Rs.10 par value Rs.600,000
Ordinary shares premium Rs.300,000
Unappropriated retained earnings Rs.584,000
During the year 2004, the following transactions occurred:
July 16: The board of directors of the company appropriated Rs.160,000 of retained
earnings for the plant expansion.
Dec. 12: Declared a stock dividend of Rs.1.50 per share.
Dec. 31: Closed the net of Rs.200,000 from income summary account to retained
earnings.
REQUIRED
(a) Prepare journal entries to record the above transactions.
(b) Prepare retained earnings statement for the year 2004.
(c) The stock dividend was issued on January 10, 2005. The market value of ordinary shares
is Rs.15 per share. Make necessary journal entries.

Question # 17: 2008 Regular & Private – BIEK

The income statement of Sana Mariam Ltd. for the year ended 31st March, 2008, showed the net
income of Rs.500,000. The board of directors decided:
(i) To declare Rs.100,000 cash dividend and Rs.150,000 stock dividend. (No. of issued
shares 15,000 of Rs.10 each against the stock dividend).
(ii) To appropriate reserve for contingencies Rs.100,000 and plant extension Rs.300,000.
REQUIRED
(a) Pass journal entry for the transfer of net income to retained earnings having credit
balance of Rs.400,000.
(b) Journalize the directors’ decision No. 1 and 2 above.
(c) Prepare the statement of retained earnings on 31.3.2008.

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Question # 18: 1990 Regular & Private – BIEK
The following balances appeared in the ledger of Shahid and Co. Ltd. on December 31, 1989:-
50,000 7% preference shares of Rs.20 each Rs.1,000,000
100,000 ordinary shares of Rs.10 each Rs.1,000,000
Retained earnings un-appropriated Rs.500,000
At this date the company decided as under:-
(i) To declare cash dividend at 15% on ordinary shares.
(ii) To declare normal dividend on preference shares for which ordinary shares at par were
issued.
(iii) To appropriate Rs.40,000 for contingencies.
(iv) To appropriate Rs.60,000 for debenture redemption, and
(v) To appropriate Rs.30,000 for plant expansion.
The company was informed by its bankers that cash dividend was collected on 64,000 ordinary
shares and stock dividend was collected on 44,000 preference shares by December 31, 1989.
REQUIRED
(a) Give entries in General Journal in proper form on the books of Shahid and Co. Ltd. to give
effect to the above decision, and
(b) Prepare a partial Balance Sheet of the above company as of December 31, 1989 after
giving effect to the above decisions.

Question # 19: 2011 Private – BIEK

The following balances appeared in the ledger of Aqeel Company Ltd. on December 31st, 2010:
500,000 Ordinary shares of Rs.10/- each Rs.5,000,000/-
Retained earnings un-appropriated Rs.1,400,000/-
On this date, the company decided as under:
(i) To declare cash dividend at 15% on ordinary shares.
(ii) To declare stock dividend at 10% on ordinary shares.
(iii) To appropriate Rs.70,000/- for contingencies.
(iv) The company was informed by its banker that cash dividend was collected by 400,000
ordinary shareholders on December 31st, 2010.
REQUIRED
Give entries in General Journal in proper form on the books of Aqeel Company Ltd. to give effect
to the above decisions.

Question # 20: 2011 Regular – BIEK

Few transactions were posted in Retained Earnings account of Man & Co.
Retained Earnings
Dec. 31, 2010 Jan. 1. 2010 Balance 1,500,000
ii) Cash dividend 400,000 i) Expense & revenue summary 400,000
iii)Reserve for building expansion 160,000
iii) Reserve for sinking fund 60,000
iv) Reserve for contingencies 80,000
Balance (Cr.) 1,200,000
1,900,000 1,900,000
REQUIRED
Prepare journal entries from above ledger.

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Question # 21: 1997 Regular & Private – BIEK
The following are the selected balances of Star Company Ltd.:-
Reserve for income tax 12,000
Retained earnings 140,000
Reserve for plant extension 15,000
Reserve for legal charges 20,000
REQUIRED
With reference to the above data record the following in the General Journal:-
(i) Reserve for contingencies is created with Rs.20,000.
(ii) Income tax liability is paid.
(iii) Reserve for plant extension is disposed of completely.
(iv) Reserve for legal charges is raised by Rs.10,000.
(v) Reserve for depreciation on machine is created with Rs.7,000.

Question # 22: 2002 Regular – BIEK

Gul & Company Ltd. decide to appropriate Rs.40,000/- for the replacement of machinery. For
this purpose, the company sets aside Rs.40,000/- cash, and the amount is invested in
government securities. At the end of the year, the interest accrued was Rs.4,000/-.
REQUIRED
Prepare General Journal entries to record the above transactions, giving explanation below each
entry.

Question # 23: 2003 Private – BIEK

Rafat Limited had a debit balance of Rs.35,000 in cash account and a credit balance of Rs.50,000
in retained earnings account. It appropriated Rs.20,000 for debenture redemption, and set
aside an equal amount of cash for this purpose.
REQUIRED
Prepare:
(i) General Journal entries for the creation of reserves and fund.
(ii) Partial balance sheet, reporting the relevant data.

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MULTIPLE CHOICE QUESTIONS (MCQS)

1) At the beginning of the current year, Wilson Corporation had 200,000 shares of
Rs.10 par ordinary shares outstanding and had retained earnings of Rs.4,800,000.
During the year, the company earned Rs.1,675,000 & paid a year-end cash dividend
of Rs.3 per share. What were Wilson’s retained earnings at the end of the year?
a) Rs.4,800,000 b) Rs.5,875,000 c) Rs.6,275,000 d) Rs.6,475,000

2) After the first year of operations, the Retained Earnings account has a debit balance
of Rs.4,000. This most likely indicates which of the following occurred?
a) An error in the closing entries b) A reported net loss for the period
c) All revenue accounts were not closed d) A posting error

3) XYZ Ltd has a net profit of Rs.180,000, a dividend on ordinary share capital of
Rs.45,000 has been declared and the company will transfer Rs.50 000 to a capital
reserve. What is the retained profit figure for the year?
a) Rs.180,000 b) Rs.135,000 c) Rs.85,000 d) Rs.267,000

4) XYZ Ltd has declared an ordinary share dividend of Rs.200,000 at 1.12.2001. Which
of the following correctly explains the accounting entries for the dividend at the
year end?
a) Expense in profit and loss account, creditor on the balance sheet
b) Appropriation of profit, reserve on the balance sheet
c) Appropriation of profit, current liability on the balance sheet
d) Expense in profit and loss account, reserve on the balance sheet

5) When net income is transferred to retained earnings account which account is

debited?
a) Expense and revenue summary account b) Retained earnings account
c) Reserve for plant extension account d) Reserve for contingencies account

6) General reserves is/are classified as:

a) Assets b) Liabilities
c) Shareholders’ equity d) None of these

7) This account is not closed at the end of accounting period:

a) Retained earning b) Purchases c) Sales d) None of these

8) Negative retained earnings means:

a) Net loss b) Gross profit c) Net profit d) None of these

9) Dividend can be described as:

a) A share of a company's profit b) Interest paid on a company's borrowings
c) Always paid to banks and other creditors d) None of the above

10) Joint stock company paid profit to its shareholders known as:
a) Commission b) Interest c) Dividend d) Profit

11) Which of the following account is used for holding of accumulated profit of the
Corporation?
a) Expense and revenue summary b) Share capital
c) Retained earnings d) Reserve account

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12) Which of the following account is used in terms of limited company for transfer of
net income or loss?
a) Income summary account b) Share capital
c) Retained earnings d) Reserve account

13) Profit is paid by corporations to its shareholders in shape of cash is known as:
a) Stock dividend b) Bank dividend
c) Cash dividend d) Rupees dividend

14) Profit is paid by corporations to its shareholders in shape of shares is known as:
a) Stock dividend b) Bank dividend
c) Cash dividend d) Rupees dividend

15) Retained earnings is increases by:

a) Net loss b) Gross profit
c) Share premium d) Net profit

16) Retained earnings is classified as:

a) Expense b) Equity c) Asset d) Liability

17) The normal balance of retained earnings account is:

a) Credit b) Debit c) Negative d) Zero

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