What is an Accumulated Deficit?
The Accumulated Deficit line item arises when a company’s cumulative profits to date have become negative, which most often stems from either sustained accounting losses or dividends.
How to Calculate Accumulated Deficit (Step-by-Step)
An accumulated deficit occurs when a company has incurred more losses than profits since its inception.
On the balance sheet, a company’s retained earnings line item — the cumulative earnings carried over and not distributed to shareholders as dividends — serves virtually the same purpose as the accumulated deficit.
Hence, the term “accumulated deficit” can be used interchangeably with “retained loss.”
But for purposes of financial reporting, companies with a negative retained earnings balance will often opt to report it as an accumulated deficit.
Accumulated Deficit Formula
The formula for retained earnings equals the prior year’s retained earnings plus the current period’s net income, less any dividends paid out to shareholders.
- Retained Earnings / (Accumulated Deficit) = Prior Balance + Net Income – Dividends
How to Interpret Negative Retained Earnings
If a company’s retained earnings balance becomes negative, that could often be a cause for concern. But negative retained earnings should be interpreted as a bad sign only if the cause is mounting accounting losses.
In the worst-case scenario, the company has frequently sustained significant losses (i.e. negative net income), resulting in a negative retained earnings balance.
But one consideration is where the company is currently at in its lifecycle. For instance, growth-oriented startups and early-stage companies reinvesting heavily into themselves to support future growth and scale will incur substantial capital expenditure (CapEx), sales & marketing expenses, and research and development (R&D) expenses.
Other exceptions where negative retained earnings are not necessarily a negative sign include the payout of dividends, which contributes to lower (or even negative) retained earnings.
In the case of dividends, the cause of the negative retained earnings is actually beneficial to shareholders since more capital is distributed to shareholders (i.e. direct cash payments are received).
Tesla (TSLA) Accumulated Deficit Example
In Tesla’s 2021 10-K, we can see how their balance sheet’s retained earnings line is stated as “Retained earnings (accumulated deficit)”.
Tesla Balance Sheet (Source: TSLA 10-K)
When Tesla’s retained earnings balance was negative in FY-20, it was reported as an accumulated deficit.
If the accumulated deficit keeps on increasing year after year how do we account for that and the business has no loans