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In part a – projection 1
Why is all the cash used for the buyback of shares?
As per my understanding, what I did was:
Beginning of 20×6
Cash 7.6+2.4 = 10
Retained Earnings 2.6+2.4 = 5mEnd of the year, they have to buy back:
Cash = 5m
Retained Earnings = 0I did this because my understanding is that retained earnings are used to make large purchases or for large outflows of cash. So I used the retained earnings first to pay off and then took the balance from cash.
In the question, Did they take the entire amount from cash to make sure the SOFP balance? Or maybe I have a fundemental misunderstanding of how Retained Earnings work?
Please help thank you
I think that you do misunderstand retained earnings (and it is a financial accounting concept rather than an AFM one).
Retained earning are simply the profits that have been retained over the years (the accumulated profits less any dividends that have been paid).
As a company makes profits, their assets increase and the retained earnings increase.
It is cash that is needed to purchase assets and to pay expenses.
Purchasing non-current assets reduces the cash and increases the non-current assets – retained earnings do not change.
Paying expenses reduces cash, and also reduced profits and therefore reduced retained earnings.
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