Compensation of deficit and loss

Difference between “compensation of deficit” and “compensation of loss”

A “compensation of deficit” and “compensation of loss” are often mixed up, but those are aiming for different result. This article explains the differences between those two.

Compensation of deficit

When a Kabushiki-Kaisha (a join-stock company) wants to “compensate deficit,” the ultimate aim for the procedures are to refill a distributable amount.

The distributable amount is the maximum amount that a company can distribute to its shareholders when it pays dividends from surplus or re-purchases its own shares.

If a company pays a dividend of 2 million yen to its shareholders when it has only 1 million yen of distributable amount, that is an illegal act and directors have to take their responsibility.  

Approximate amount distributable amount (excluding cases where the company disposes of its own shares):
Other capital surplus + other retained earnings – book values of treasury stock.  

* The amount of treasury stock used in the above formula is the amount excluding it’s minus figure shown in a balance sheet.

* As the actual legal formula is more complicated, it is highly recommended to have tax accountant calculate the specific distributable amount when necessary..

Net Assets before compensating deficit
Shareholders’ equity 11 million
Capital 20 million
Capital surplus 5 million
　Other capital surplus 5 million
Retained earnings (9 million)
　Other retained earnings (9 million)
Treasury stock (5 million)

In the above case, there are deficit of -9 million yen (5 million + (-9 million) -5 million).

To eliminate this deficiency, the amount of capital or capital reserve shall be transferred to other capital surplus. In the above case, there is no capital reserve, but has 20 million yen in capital, so 9 million yen can be transferred from capital to eliminate deficit.
Note: Creditor protection procedures are required for capital reduction.

Net Assets as a result of transfer
Shareholders’ equity 11 million
Capital 11 million
Capital surplus 14 million
　Other capital surplus 14 million
Retained earnings (9 million)
　Other retained earnings (9 million)
Treasury stock (5 million)　

Deficits have been eliminated (14 million + (-9 million) -5 million = 0)

Compensation of Losses

When a company wants to Compensate of losses, the ultimate aim for the procedures are to eliminate the negative amount in “other retained earnings”. In other words, it is an attempt to eliminate the losses by transferring the amounts in other capital surplus to other retained earnings (generally, to retained earnings brought forward). However, the following rules apply to such treatment of losses.

Rule: The maximum amount of losses that can be treated is the negative amount of retained earnings (legal reserve + other retained earnings) on the finalized balance sheet.

Therefore, a company which fascial year ends in December 31st is not allowed to immediately make up the amount of loss just because it incurred a loss in March.

In above case, the maximum amount that can be transferred from other capital surplus to other retained earnings is 7 million yen as of December 31. However, there is only 5 million yen in other capital surplus, which means it still leaves a loss of -2 million yen.

To eliminate all of this, the capital or capital reserve shall be transferred to other capital surplus, and then transfer such increased other capital surplus to other retained earnings. In the above case, there is no capital reserve, yet has 20 million yen in capital, so 2 million yen can be transferred from capital to other capital surplus which makes other capital surplus 7 million yen, then transfer the full amount to other retained earning.

Note: Creditor protection procedures are required for capital reduction.

MK @ 10/19/2022