Retained profits look like loans
WM writes: I am the company secretary of a small limited company with income arising on investment property, although we had previously been a trading company. We believe the shareholders have been overpaid a total of approximately £30,000 over a number of years, as this amount is shown in our accounts as ‘retained profits’. We would like to write off this amount as an exceptional item as it must be incorrect and the company does not have the corresponding cash resources to pay a £30,000 dividend. However, our auditors say the write off cannot be made and suggest we obtain a bank overdraft to pay the profits to the shareholders. Are they right?
As your accounts still show the retained profits, any overpayments to shareholders would show as a loan to the shareholders, repayable to the company, writes Jon Sutcliffe, partner at Kingston Smith LLP. Alternatively, the overpayments may have been shown as additional dividends, but the existence of retained profits suggests this is not the case.
It therefore appears that the shareholders have not been overpaid, and a quick look at your accounts confirms this. Instead, it appears that you are confused about how your company can have £30,000 of retained profits showing on the balance sheet, but not have any cash to show for it. This confusion is common and is caused by the business using the profits to finance other assets.
In your company’s case, profits will have been used to finance the acquisition of the investment property – albeit many years ago. In the absence of these profits, the company would have needed other finance. This could typically have been a bank loan or overdraft, as implied by the comment from your auditors, or investment from shareholders either by way of a loan or increased share capital.
It is possible to capitalise the retained profits into additional share capital, but unless you have a specific need to show increased share capital, there is no real benefit in doing this.