What is Undivided Profit?
Undivided profits refer to gains from current and past years that have not been transferred to a surplus account or distributed as dividends to shareholders. Often, financial gains or budget surpluses are set aside in a separate account designated as surplus, earmarked for distribution as dividends, or assigned to funding projects.
Essentially, undivided profit is corporate earnings that have been allowed to accumulate over time instead of being disbursed for other purposes.
Key Takeaways
- Undivided profits are gains from current and past years not transferred to a surplus account or distributed as dividends to shareholders.
- Current earnings may be credited to the undivided profits account and will eventually either be distributed to shareholders in the form of dividends or held within the company as retained earnings.
- Undivided profit can also be considered a company’s overall profits re-invested into the company.
Understanding Undivided Profit
Current earnings may be credited to the undivided profits account and will eventually either be distributed as dividends or held within the company as retained earnings. Dividend distributions signal strong financial health within the company, while retained earnings can be utilized to spur future growth. The preferred strategy can depend on supported profit levels and prospective value-maximizing projects.
Undivided profit generally reflects a public company’s earnings after tax. Since these funds are not initially earmarked for dividends (as surplus account funds are), they count as part of the company’s equity until transferred. This profit can be re-invested into the company when not allocated as dividends.
The distinction between a bank’s undivided profits account and its surplus fund was explicitly recognized by the United States Supreme Court in 1925, in Edwards v. Douglas. The ruling clarified: ‘By incorporated banks, the term (undivided profits) is commonly employed to designate the account in which profits are carried more or less temporarily, in contrast to the surplus account which holds amounts treated as permanent capital, derived from surplus payments for stock in excess of par or profits distinctly dedicated to capital use.’
An Inspirational Example of Undivided Profit
The classification of undivided profits for banks became a topic of debate in 1964 with the Federal Reserve Bank of Dallas. The discussion centered on whether undivided profits should be counted as part of the bank’s capital or surplus.
Based on an examination of the Supreme Court ruling, the then-president of the Federal Reserve Bank of Dallas concluded that ‘undivided profits do not constitute “capital”, “capital stock”, or “surplus” for purposes of provisions of the Federal Reserve Act’. These provisions set limits for member banks on areas like loans to affiliates and investment securities, indicating that while undivided profits hold importance, they exist in a distinct categorization.
Facing similar financial differentiations can help businesses and institutions properly allocate resources, aiding both compliance and strategic growth.
Related Terms: retained earnings, dividends, surplus account, corporate finance.
References
- Justia U.S. Supreme Court. “Edwards v. Douglas, 269 U.S. 204 (1925)”.
- Federal Reserve Bank of Dallas. “Undivided Profit as Part of ‘Capital’, ‘Capital Stock’ or ‘Surplus’”.
