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Retained earnings of Relx (REL) and general equity queries

Analysing companies' finances and value from their financial statements using ratios and formulae
TheMotorcycleBoy
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Retained earnings of Relx (REL) and general equity queries

#203005

Postby TheMotorcycleBoy » February 21st, 2019, 7:09 pm

Hi folks,

I've put together a company valuation spreadsheet and some of the outputs comprise the "Altman Z" scores. An input into the Altman-Z is the "Retained Earnings" which is (I think) the accumulated value of earnings, which aren't used to buy back shares or pay towards dividends. To be quite honest I don't actually know exactly what this value "looks like" in physical terms (i.e. is it cash+accumulated fixed assets/investments etc.), but it is present in most firm's equity statements.

In the statement for Relx, this exact value is not stated in as a single simple term. From https://www.relx.com/~/media/Files/R/RE ... report.pdf at page 121, I paste a simplified copy of the equity statement:



(Note that the fourth column is used what I used for workings out in my spreadsheet, and to illustrate, what I believe to be the representative value for this data for Relx in 2017)

Now, I suspect that the figure which I am looking for (i.e. the value for "Retained Earnings") is actually 169 + 487 = 656, i.e. the sum of the two entries labelled as being reserves of some sort. But could anyone confirm/refute this assumption for me?

Out of interest I note the balance sheet of RELX according to Morningstar also summarises those two entries (that 169 and 487) - however it describes these "Accumulated other comprehensive income" (i.e. not retained earnings). But since accumulated is almost synonymous with retained, I'm hedging my bets that my current assumption could well be correct...

Can anyone help?
many thanks Matt

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Re: Retained earnings of Relx (REL) and general equity queries

#203066

Postby TheMotorcycleBoy » February 22nd, 2019, 6:16 am

Some interesting stuff about the classifications in the Equity Statement (with slight relevance to the "Retained Earnings" entry) from a HYP post.

Gengulphus wrote:
Alaric wrote:There's an accounting line in the sand where capital employed is separated into "original" capital and accumulated profits ("reserves"). Distributions and buybacks are most simply made from accumulated profits. Making them from "original" capital seems to involve cancelling shares and issuing new ones of a lower face value.

Just to clarify that: The items listed under "Capital and reserves" on a company's balance sheet are either "distributable" or "non-distributable". Only distributable reserves can be used for distributions and buybacks, and they may not be driven negative or further negative by those uses. The main distributable reserve is normally the one for accumulated profits (which I've seen various names for, such as "retained earnings" or "profit and loss reserve"), and it can be negative as a result e.g. of having been driven down to a low figure by paying dividends and the company then having made a loss.

What about using the term: "Accumulated other comprehensive income" as in MorningStar's summary of two entries in Relx's Equity Statement, which Relx refers to as reserves of some type?

The main non-distributable reserves are "Share capital" and "Share premium". Share capital is basically just the total nominal value of the shares in issue - so if there's only one class of shares in issue, it's just the number of shares in issue times the nominal value per share. The share premium reserve arises because companies normally raise much more than the nominal value of a share when they issue new shares: it is basically the total over all issued shares of that premium obtained over their nominal value. (And incidentally, it's never negative: companies are not allowed to issue shares for less than their nominal value.)

Although distributions and buybacks may not be made from non-distributable reserves, the same effect can be achieved in two steps by reclassifying (and generally renaming) the non-distributable reserve as distributable, then using it for distributions and/or buybacks. The first of those steps does however require both shareholder and Court approval, and I believe the company's creditors can raise objections to it with the Court. So taking it involves significant administrative and legal costs for the company.

Other than the admin and costs, that first step is generally fairly simple when the company wants to use its share premium reserve for distributions and/or buybacks - it just involves reducing the share premium reserve and increasing or creating a distributable reserve correspondingly. The process is more complicated if they've exhausted the share premium reserve and any other non-distributable reserves than the share capital: to reduce the share capital, they have to do a share reorganisation that reduces the number of shares in issue and/or the nominal price of a share (without increasing the other one correspondingly). A typical way to do that is to subdivide Ordinary shares into new Ordinary shares and Deferred shares, with the Deferred shares being given part of the nominal value but being made practically worthless and redeemable by the company for effectively nothing, then later redeeming and cancelling the Deferred shares (an example of that is Segro's rights issue in 2009, though that was done to get around the awkward fact that the nominal value of the shares was 27 1/12 pence and they wanted to issue the rights issue shares for 10p each rather than to make reserves distributable).

If anyone is wondering why they've never heard a company doing something like that, by the way, it's the sort of corporate action that companies tell their registered shareholders about via their registrars (often in excruciating detail!), but that nominee brokers don't usually pass on to their customers unless it's part of a more obviously relevant corporate action (such as that rights issue) and even then, it's typically in detail that gets simplified away in the interests of conciseness. So not having heard about any such actions can very easily be caused by holding one's shares in a nominee account - as well as for more obvious reasons such as not having had enough holdings for long enough to make it particularly likely that any of them has had cause to do such an action.

One other important point to note about the legal restriction on driving distributable reserves negative or further negative with distributions or buybacks is that it is a restriction on companies, not on groups of companies. So if you want to know where a company lies with respect to it, you need to look at the parent company balance sheet, not the consolidated balance sheet. For instance, BAE Systems' annual report for 2017 shows retained earnings as -£2,693m of the consolidated balance sheet (on page 146 of the report) but +£2,600m on the parent company balance sheet (on page 203 of the report). It's the latter that determines the company's ability to pay dividends, so it hasn't had any problems doing so.

Gengulphus

Matt

PS Sorry if the above content is "cross-posting" but I was keen on pulling the information over here, since I believe it starts to clarify one or two queries I have re. equity, capital, and retained earnings.

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Re: Retained earnings of Relx (REL) and general equity queries

#203283

Postby TheMotorcycleBoy » February 22nd, 2019, 6:39 pm

Been doing a bit of reading and youtube watching about equity and equity statements. One of the problems I'd encountered so far was that lots of the firms financial statements use different terms to mean similar things.

What I'm now understanding is there are 2 components to the eq. statements, i.e. non-distributable and distributable entries. What I've found online is these are also at times called:

1. Capital stock
2. Retained Earnings

I believe that capital stock is non-distributable (i.e. as I stated above) and I *think* can have 3 common entries:

1. Share capital (the nominal value of shares currently in issue)
2. Share premium (the difference between the issued price of shares, which legally cannot be less than nom. value, and the nominal value)
3. Treasury stock

I *think* that Treasury stock, is sometimes also called treasury shares, and maybe "own shares".

There's also a thing called "Capital redemption reserve" but I'm yet to figure this one out yet...

Reserves, I think are distributable. But the precise, accounting wise, differences between the different reserve entries and retained earnings is currently beyond me. It seems that some firms list entries called hedging reserves (I guess this is where gain/losses on derivatives contracts go?) and also translation reserve (I think this has to do with FX gains and losses).

Here's a shot of a firm's (Marshall Plc) equity statement, I think the first 3 or 4 entries are non-distributable, and the last few (?) are.



Here's one of the more useful pieces of online info I've found so far:
https://accountingexplained.com/financi ... ers-equity

that's all for now.

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Re: Retained earnings of Relx (REL) and general equity queries

#208111

Postby MaynardPaton » March 16th, 2019, 8:48 pm

“I've put together a company valuation spreadsheet and some of the outputs comprise the "Altman Z" scores. An input into the Altman-Z is the "Retained Earnings" which is (I think) the accumulated value of earnings, which aren't used to buy back shares or pay towards dividends.”


Yes, ‘retained earnings’ generally reflects the earnings retained by the business less paid dividends and amounts used to buy and then cancel shares. Items such as ‘share-based payments’ and entries relating to other share-type option schemes can affect this reserve, too, but such balance-sheet movements are mostly unimportant to investors (the generosity of option schemes can be assessed through other ways). Movements within a defined-benefit pension scheme may also feature in retained earnings.

“To be quite honest I don't actually know exactly what this value "looks like" in physical terms (i.e. is it cash+accumulated fixed assets/investments etc.), but it is present in most firm's equity statements.”


‘Retained earnings’ is a bookkeeping concept and does reflect anything physical. The actual money retained by the business over the years could be reinvested in a spread of assets on the balance sheet.

“In the statement for Relx, this exact value is not stated in as a single simple term. From... at page 121, I paste a simplified copy of the equity statement:

Balance.at.31.December.2017
Share capital 224
Share premium 3104
Shares held in treasury -1631
Translation reserve 169 169
Other reserves 487 487
Total of “reserves” 656
Share holders equity 2353


(Note that the fourth column is used what I used for workings out in my spreadsheet, and to illustrate, what I believe to be the representative value for this data for Relx in 2017)

Now, I suspect that the figure which I am looking for (i.e. the value for "Retained Earnings") is actually 169 + 487 = 656, i.e. the sum of the two entries labelled as being reserves of some sort. But could anyone confirm/refute this assumption for me?”


RELX is not the easiest of examples to use. The balance sheet on page 121 refers to note 27 for ‘other reserves’, which then states ‘Other reserves principally comprise retained earnings and the share based remuneration reserve.’

The total of ‘other reserves’ is 487, comprising a Hedge reserve of (3) and Other reserves of 490. So 490 is the real ‘retained earnings’ figure’.

The translation reserve (169) reflects valuation changes to non-monetary assets/liabilities due to currency movements.

“Out of interest I note the balance sheet of RELX according to Morningstar also summarises those two entries (that 169 and 487) - however it describes these "Accumulated other comprehensive income" (i.e. not retained earnings). But since accumulated is almost synonymous with retained, I'm hedging my bets that my current assumption could well be correct…"




I think Morningstar lumped ‘translation reserve’ and ‘other reserves’ together in the catch-all “accumulated other comprehensive income” as neither was stated on the balance sheet as ‘retained earnings’. Note 27 had to be inspected to find what exactly was going on, and Morningstar’s data-entry people will not spend hours untangling all these numbers for you. In fact, data providers such as Morningstar should not be taken as gospel and by looking at note 27, you will now know more about RELX than any data clerk.

“Been doing a bit of reading and youtube watching about equity and equity statements. One of the problems I'd encountered so far was that lots of the firms financial statements use different terms to mean similar things.

What I'm now understanding is there are 2 components to the eq. statements, i.e. non-distributable and distributable entries. What I've found online is these are also at times called:

1. Capital stock
2. Retained Earnings

I believe that capital stock is non-distributable (i.e. as I stated above) and I *think* can have 3 common entries:

1. Share capital (the nominal value of shares currently in issue)
2. Share premium (the difference between the issued price of shares, which legally cannot be less than nom. value, and the nominal value)
3. Treasury stock

I *think* that Treasury stock, is sometimes also called treasury shares, and maybe "own shares”.”


Yes, I think you are right with all of this.

“There's also a thing called "Capital redemption reserve" but I'm yet to figure this one out yet…”


This is a non-distributable reserve that reflects the nominal value of shares purchased and cancelled. Say a company issues shares with a nominal value of £100, of which shares with a £25 nominal value are purchased and cancelled. The share capital reserve goes from £100 to £75 and a capital redemption reserve is created at £25.

“Reserves, I think are distributable. But the precise, accounting wise, differences between the different reserve entries and retained earnings is currently beyond me. It seems that some firms list entries called hedging reserves (I guess this is where gain/losses on derivatives contracts go?) and also translation reserve (I think this has to do with FX gains and losses).”


I think the only real distributable reserve is ‘retained earnings’ — or at least that is the only reserve I have seen used for dividends. Your verdict on hedging reserves etc is broadly correct — certain hedges go through the P&L, others straight to the balance sheet. Only if the numbers are significant do you need to study what exactly is going on with these less prominent reserve entries.

“Here's a shot of a firm's (Marshall Plc) equity statement, I think the first 3 or 4 entries are non-distributable, and the last few (?) are.

ENTRY VALUE . . . .
share capital 49845 . . . .
share premium 22695
own shares -3622
capital redemption reserve 75394
consolidation reserve -213067
hedging reserve 590
retained earnings 283821
total owner equity 215656”




For the last few years at least, dividends have been paid only from the company’s retained earnings reserve For practical purposes, I would venture the only distributable reserve at Marshalls at least is retained earnings.

Maynard

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Re: Retained earnings of Relx (REL) and general equity queries

#208344

Postby TheMotorcycleBoy » March 18th, 2019, 9:41 am

MaynardPaton wrote:
“I've put together a company valuation spreadsheet and some of the outputs comprise the "Altman Z" scores. An input into the Altman-Z is the "Retained Earnings" which is (I think) the accumulated value of earnings, which aren't used to buy back shares or pay towards dividends.”


Yes, ‘retained earnings’ generally reflects the earnings retained by the business less paid dividends and amounts used to buy and then cancel shares. Items such as ‘share-based payments’ and entries relating to other share-type option schemes can affect this reserve, too, but such balance-sheet movements are mostly unimportant to investors (the generosity of option schemes can be assessed through other ways). Movements within a defined-benefit pension scheme may also feature in retained earnings.

“To be quite honest I don't actually know exactly what this value "looks like" in physical terms (i.e. is it cash+accumulated fixed assets/investments etc.), but it is present in most firm's equity statements.”


‘Retained earnings’ is a bookkeeping concept and does not reflect anything physical. The actual money retained by the business over the years could be reinvested in a spread of assets on the balance sheet.

Thanks, yes. I'm completely clear about this point now i.e. the conceptual aspect. In my opinion, Retained Earnings is just an accumulation of all the earnings (i.e.money after all costs, interest and tax), that didn't then proceed to "go out of the building", into the pockets of the shareholders.

Matt

PS I believe I applied a slight correction in my above quote of yours, i.e. the addition of the word not into does reflect anything physical. Correct me if I'm wrong.

PPS I'm still chewing on the rest of you post....

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Re: Retained earnings of Relx (REL) and general equity queries

#208465

Postby TheMotorcycleBoy » March 18th, 2019, 5:57 pm

MaynardPaton wrote:
“In the statement for Relx, this exact value is not stated in as a single simple term. From... at page 121, I paste a simplified copy of the equity statement:

Balance.at.31.December.2017
Share capital 224
Share premium 3104
Shares held in treasury -1631
Translation reserve 169 169
Other reserves 487 487
Total of “reserves” 656
Share holders equity 2353


(Note that the fourth column is used what I used for workings out in my spreadsheet, and to illustrate, what I believe to be the representative value for this data for Relx in 2017)

Now, I suspect that the figure which I am looking for (i.e. the value for "Retained Earnings") is actually 169 + 487 = 656, i.e. the sum of the two entries labelled as being reserves of some sort. But could anyone confirm/refute this assumption for me?”


RELX is not the easiest of examples to use.

Totally agree....but I was attempting to analyse this company in general, so I felt obliged to review this.

The balance sheet on page 121 refers to note 27 for ‘other reserves’, which then states ‘Other reserves principally comprise retained earnings and the share based remuneration reserve.’

The total of ‘other reserves’ is 487, comprising a Hedge reserve of (3) and Other reserves of 490. So 490 is the real ‘retained earnings’ figure’.

The translation reserve (169) reflects valuation changes to non-monetary assets/liabilities due to currency movements.

Ok. I see that in your analysis you've not included the translation reserve. I have now spent some time googling and reading about what this entry is:

e.g.
https://en.wikipedia.org/wiki/Reserve_(accounting)
http://www.infosysblogs.com/oracle/2017 ... rency.html

so I think that I now have a slight grasp of what translation reserve is. In simple terms, it seems to be an accounting bucket representing the net financial position due to all the foreign currencies which the firm either has in credit, or owes. What I don't understand is why they have to be non-monetary? Surely we are talking about Dollars or Euros etc. here?

Also how do we know if this foreign currency position didn't originally emanate from retained profit, i.e. not from equity lent by shareholders?

Matt

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Re: Retained earnings of Relx (REL) and general equity queries

#208481

Postby TheMotorcycleBoy » March 18th, 2019, 7:12 pm

MaynardPaton wrote:This is a non-distributable reserve that reflects the nominal value of shares purchased and cancelled. Say a company issues shares with a nominal value of £100, of which shares with a £25 nominal value are purchased and cancelled. The share capital reserve goes from £100 to £75 and a capital redemption reserve is created at £25.

Ah ha. Another conceptual entity. I did just read quite an interesting tale discussing "lenders and owners" that helped me with this.

However, am I not correct in stating that to fully account for the example that you laid out above, one must also accept that £25 must have left the firm in order to repurchase the stock. So, provided the firm paid for the shares in cash then £25 is deducted from their cash+equivalents assets, and the same £25 must be reduced from their retained earnings (claims) in order to keep the balance sheet balanced. Correct?

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Re: Retained earnings of Relx (REL) and general equity queries

#208546

Postby TheMotorcycleBoy » March 19th, 2019, 8:08 am

I read this which sheds light on why assets/liabilities may be either monetary or non-monetary:

https://www.ifrsbox.com/monetary-non-monetary/

so I can see why some components in translation reserves (e.g. fixed assets owned by the company in a foreign country and purchased in that country) will be "non-monetary".

But I don't understand why those things can be ruled out of the "Retained Earnings" basket, since they may have been purchased with funds derived from profitable activities, and obviously were not then handed out to shareholders.

Matt

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Re: Retained earnings of Relx (REL) and general equity queries

#208556

Postby tjh290633 » March 19th, 2019, 9:15 am

Haven't they become assets?

TJH

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Re: Retained earnings of Relx (REL) and general equity queries

#208568

Postby TheMotorcycleBoy » March 19th, 2019, 10:10 am

tjh290633 wrote:Haven't they become assets?

TJH

(I assume that you are replying to this point of mine: But I don't understand why those things can be ruled out of the "Retained Earnings" basket, since they may have been purchased with funds derived from profitable activities, and obviously were not then handed out to shareholders.)

My point is that they could still have emanated from retained earnings. See Maynard's earlier post.

i.e.
‘Retained earnings’ is a bookkeeping concept and does reflect anything physical. The actual money retained by the business over the years could be reinvested in a spread of assets on the balance sheet.

Matt

PS in my limited view, retained earnings in the equity statement (or balance sheet, since some firms record the same figure there too) is a merely an accumulation of earnings which were not used to reward shareholders (i.e. not divis or share buybacks)......so whether those earnings eventually result in becoming assets fixed or otherwise, foreign currency or local presentation currency denominated is immaterial.

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Re: Retained earnings of Relx (REL) and general equity queries

#208624

Postby TheMotorcycleBoy » March 19th, 2019, 2:09 pm

Ah, I think I understand now.

None of these four:

Hedging reserve
Consolidation reserve
Translation reserve
Revaluation reserve

comprise the financial total for "Retained earnings". I believe that all those four things above that I have called "reserves" are merely gains/losses accumulated in those areas.

As an example at the end of year N, we could have a very simple Equity statement like this:

Share capital 100
Hedging reserve 0
Translation reserve 0
Retained earnings 200
Total equity 300

Then over the next year we make £100 net profit and pay out £10 of divis. We also acquire from our cash supply (yes either from equity, loan, or retained earnings), £10 of interest rate derivatives, and £10 worth of foreign currency. At the year end our derivatives are worth £2 more, but our foreign currency reserve has fallen in value by £4 so therefore the Equity statement looks like this at end of year N+1:

Share capital 100
Hedging reserve 2
Translation reserve -4
Retained earnings 290
Total Equity 388

So the retaining earnings bucket is not effected by the hedging and translation reserves since they record the ongoing difference (gain/loss). Retaining earnings is only changed by the net profit for the year not reduced by divis (or buybacks). However Total equity summarises all of these entries.

Can anyone confirm if I now have things right?
thanks Matt

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Re: Retained earnings of Relx (REL) and general equity queries

#208679

Postby TheMotorcycleBoy » March 19th, 2019, 4:15 pm

TheMotorcycleBoy wrote:Then over the next year we make £100 net profit and pay out £10 of divis. We also acquire from our cash supply (yes either from equity, loan, or retained earnings), £10 of interest rate derivatives, and £10 worth of foreign currency. At the year end our derivatives are worth £2 more, but our foreign currency reserve has fallen in value by £4 so therefore the Equity statement looks like this at end of year N+1:

Share capital 100
Hedging reserve 2
Translation reserve -4
Retained earnings 290
Total Equity 388

So the retaining earnings bucket is not effected by the hedging and translation reserves since they record the ongoing difference (gain/loss). Retaining earnings is only changed by the net profit for the year not reduced by divis (or buybacks). However Total equity summarises all of these entries.

Can anyone confirm if I now have things right?
thanks Matt

I've just realised that my above (in my last post) attempt in arriving at the Equity statement for my example at the end of Year N+1 is wrong, because the original funds for the derivatives and the foreign currency (£10 for each) must have come from somewhere. And in my simple example they must reduce the Retained Earnings entry, so therefore I now (finally!) claim the Closing statement should actually be:

Share capital 100
Hedging reserve 2
Translation reserve -4
Retained earnings 270
Total Equity 368

Tada!

Sound plausible?


Moderator Message:
Figure for retained earnings corrected at posters request from 290 to 270 (chas49)

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Re: Retained earnings of Relx (REL) and general equity queries

#209658

Postby MaynardPaton » March 23rd, 2019, 7:45 pm

Hi Matt

“However, am I not correct in stating that to fully account for the example that you laid out above, one must also accept that £25 must have left the firm in order to repurchase the stock. So, provided the firm paid for the shares in cash then £25 is deducted from their cash+equivalents assets, and the same £25 must be reduced from their retained earnings (claims) in order to keep the balance sheet balanced. Correct?”


Correct — assuming the shares were acquired at their nominal value. In reality, shares on the stock exchange mostly trade well above their nominal value.

So, if the company paid, say, £1,000 to buy back shares that carried a £25 nominal value, £1,000 would be deducted from cash while retained earnings would be reduced by £1,000. You would also have those same two £25 movements.

“But I don't understand why those things can be ruled out of the "Retained Earnings" basket, since they may have been purchased with funds derived from profitable activities, and obviously were not then handed out to shareholders.”


This question introduces the accounting concept of ‘realised’ versus ‘unrealised’ gains.

Say a UK company builds a factory in Europe. The value of that factory is translated from EUR to GBP at each balance sheet date.

Any FX gains/losses on the factory during the year are effectively only paper gains/losses and not deemed to be a ‘completed transaction’ for accounting purposes — i.e. the building was not sold. As such, the FX movement for this factory would be taken direct to the balance sheet (statement of comprehensive income) and deemed to be an ‘unrealised’ gain.

Only ‘realised' gains — i.e. those that the accounting rules deem to be ‘completed transactions’, and all of which go through the P&L (I think!) — can contribute to the retained earnings reserve.

“Sound plausible?”


Yes, I have not checked the figures but the thinking seems correct.

The main point here is to regard reserves as accounting records where various types of gains/losses each sit to distinguish between how they were generated and, more importantly, whether they are distributable or non-distributable. Strict rules mean directors have to keep track of how much can be distributed as a dividend, buyback etc.

I am not sure whether all this helps with the Altman-Z score though :-)



Maynard

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Re: Retained earnings of Relx (REL) and general equity queries

#209838

Postby TheMotorcycleBoy » March 24th, 2019, 4:53 pm

Hi Maynard,

MaynardPaton wrote:I am not sure whether all this helps with the Altman-Z score though :-)

Maynard

it's because it's one of the ingredients into the Altman-Z score calculations.

This is a quick (and somewhat economical with all my workings) screen copy from one of my recent spreadsheets for a firm that I've analysed of late?


You can see that retained earnings comprises T2.

(By the way I'm now dubious about my prior thinking in the example in this post. I may pester a mod, yet again, to help me correct this in a few days. I actually don't think that the Retained profits entry is reduced for the derivatives and the Foreign currency, since I believe the purchase of the currency and hedging instruments merely reduce a cash entry at their benefit - hence the net asset position is unchanged. And of course we still reflect that the same amount of profit is retained, and it's just the Total equity figure which is affected by any losses/gains in the reserves. I think. Will post back when have more time).


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