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Hi, please may I know whether cash and retained earnings have a correlation?
My interpretation is that for example, if a company has $10,000 cash, then it can transfer $6,000 into its retained earnings as the company’s reserves for future business uses, leaving $4,000 as its cash in the statement of financial position.
What do you think? (I interpreted this after I’ve analyzed the sample answer in BPP revision kit (Q.31 Flufftort)).
Thank you.
It is not cash that is transferred to retained earnings.
The transfer to retained earnings is the profit after tax less the dividends. This is Paper FA 🙂
I see. Please allow me to put my own interpretations for BPP revision kit Q.31 Flufftort’s sample answer:
“1. The transfer to retained earnings is the profit after tax less dividends. This is because all these are the items in statement of income & retained earnings (or P&L). Cash is not transferred to retained earnings because cash is a balance sheet item.”
“2. For part (a)(i), the retained earnings $2.6m in 20X5 is added to the retained earnings $2.4m in 20X6 (forecast) because retained earnings are accumulated over years. Over time, retained earnings (in statement of income & retained earnings) will become a component of shareholder equity (in balance sheet), which helps in calculation of company’s book value.”
“3. For part (a)(ii), the balancing figure for the cash becomes $5m because the note states that the figure shown for retained earnings in the 20X6 forecast ($5m) can be assumed to be the net increase in cash for the year ended 20X6 (which means $0 increases to $5m).”
Am I correct, or am I wrong in any parts of these? Thank you. 🙂
By the way, there is one confusion: Since 20% of Gupta shares ($10m) will be bought back, the cash of $10m will be consumed. This subtracts the entire $7.6m from the cash in SOFP as at 30.06.20X5, plus another $2.4m generated next year. However, as at 30.06.20X6, why the cash that will amount to $5m (as calculated above) is not affected by such $2.4m?
Thank you.
What you wrote is correct except that you really need to explain the first point differently. Cash and profits (which go to retained earnings) are not the same thing. For example, profit is after charging depreciation, but depreciation is not a cash payment – the cash payment is the payment to buy the asset in the first place.
As regards your second point, the question says that the net increase in cash can be assumed to be equal to the 2.4 retained earnings. This means that they will have 10m in cash, and that will be spent on buying back Gupte VC’s shares (20% x 50m), leaving a cash balance of zero.
Oh I see. That means for sample answer part (a) (ii), the cash figure (balancing figure) is $5m simply because the question states that the figure shown for retained earnings in the 20X6 forecast (which is $5m in SOFP if full refinancing takes place) can be assumed to be the net increase in cash for the year ended 30 June 20X6? Therefore, the cash now is $5m in the SOFP?
Thank you.
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