Accumulated earnings represent a company’s net profit after having distributed dividends to the stockholders. It is often used in accounting to determine how much net profits a company has left after having paid dividends. To calculate accumulated earnings, one must add the sum of the accumulated earnings at the beginning of the year to the current accumulated earnings, minus any dividend paid to stockholders. Most corporations use accumulated earning calculations to make tax determinations and to calculate the value of a tax treatment for a particular transaction.
Accumulated earnings also refer to the ability of a corporation to fund distributions. It does not represent the amount of cash left over after dividends have been paid. Instead, it reflects what a corporation has done with its profits. This includes whether they have invested it back into the business or distributed dividends out of it. Therefore, accumulated earnings reflect the company’s dividend distribution policy. Accountants make accumulated earnings most often to calculate how much profit a company makes depending on whether they decide to invest into the business or into the stockholders.
In the case of Chaney & Hope, Inc. v. Commissioner, the courts explained that in terms of accumulating earnings, if the corporation retains earnings and profits for the reasonable needs of the business, there will not be any accumulated tax.
In the case of Baker v United States, dividends can only be distributed from accumulated earnings and profits. A company whose current earning does not exceed its accumulated losses does not have accumulated earnings.
[Last updated in June of 2022 by the Wex Definitions Team]