Question

In 2007, Wagner Associates appropriated $65,000 of retained earnings to satisfy the restrictive covenant of a loan agreement. What are the financial statements effects of the appropriation

Answer 1

Answer:

The financial statements effects of the appropriation are as follows:

a) Retained Earnings will reduce by $65,000 in the Income Statement and the Balance Sheet.

b) Cash balance will also reduce by $65,000 in the Balance Sheet.

Explanation:

Normally, partnerships can distribute or appropriate their profits according to their partnership agreements.  However, there may be restrictive loan covenants that can specify how much profits partnerships can distribute among the partners.  The purpose of such covenants is to ensure that the ability of the partnership to repay loans are not compromised through profit appropriations.

Financial institutions, therefore, to secure the loans advanced to businesses may include restrictive covenants.  Some restrictive covenants may specify the minimum cash balance to maintain.  Restrictive covenants, generally, remain measures to overcome unwanted business outcomes.  It is a form of insurance against loan repayments.

Answer 2

Answer:

Reduction of $65,000 retained earnings and cash balance in the balance sheet

Explanation:

The financial statement effect of the appropriation is that

retained earnings and cash balance will reduce by $65,000 in the balance Sheet.

There are two entries on the balance sheet of a firm

(1) retained earnings and (2) cash equivalent.

1) Retained earnings refers to the running total of a firm's profits and losses. Retained earnings is basically the reinvestment of profit back into the business.

A firm can make two types of decision regarding Profit (1) return to firm's shareholders as dividend or (2) reinvent the profit into the firm.

The reinvested Profit is referred to as "retained earnings".

2) Cash equivalent refers to short-term investment that can be converted into cash within a short period of time.