RETAINED EARNINGS Retained earnings represents the accumulated earnings of the
corporation less dividends distributed to shareholders. A negative balance in the retained earnings
account is referred to as a deficit. The retained earnings account does not represent cash or any
other asset. The directors of a corporation may restrict, reserve, or appropriate retained earnings to
show that it cannot be used to distribute assets as dividends. Retained earnings may be appropriated
as result of a legal, contractual, or discretionary requirement. The appropriation of retained earning
does not set aside or reserve cash or any other asset.
TREASURY STOCK Treasury stock represents a corporation’s own stock that has been
reacquired after having been issued and fully paid. Such reacquired shares are held in the treasury
for reissue and are not retired. Treasury stock is not an asset. A corporation cannot recognize a gain
or a loss when reacquiring or reissuing its own stock. Treasury stock does not possess voting rights,
nor does it share in dividend distributions or in assets at liquidation of the enterprise. It is reported
as a reduction of stockholders’ equity in the stockholders’ equity section of a balance sheet. Most
state laws require that retained earnings be restricted in the amount of the cost of the treasury stock.
OFF-BALANCE SHEET ITEMS
Off-balance sheet items are sometimes encountered in financial statement analysis. Off-balance
sheet items generally refer to the application of procedures that provide financing without adding
debt on a balance sheet, thus not affecting financial ratios or borrowing capacity of an enterprise.
Off-balance sheet items are often related to the sale of receivables with recourse and leases.
BALANCE SHEET LIMITATIONS
The balance sheet has major limitations. First, the balance sheet does not reflect current value or
fair market value because accountants apply the historical cost principle in...