The Flow of Net Profit for the Period Becoming Internal Reserves and Being Appropriated in an Accounting System

It is said that a company’s internal reserves are not necessarily held as cash or deposits because, even though transferring profit/loss to retained earnings increases net assets, the accounts receivable, which are the substance of revenue, will eventually turn into cash or deposits. Meanwhile, the balance decreases due to capital expenditures or loan repayments, independent of the movements in net assets.

Net Assets Section of the Balance Sheet (B/S)

Net assets are recorded in the net assets section of the Balance Sheet (B/S) in one of the following forms: Legal Capital, Legal Capital Surplus, or Retained Earnings (also known as Earned Surplus). Legal Capital Surplus and Retained Earnings constitute internal reserves.
For companies with significant growth potential and many investment opportunities, rather than returning profits to shareholders through dividends, they aim for growth through reinvestment, such as purchasing fixed assets like equipment. To achieve this, they bolster internal reserves by carrying forward profits as Retained Earnings, thereby increasing the cash and deposit balance.

Additionally, under Indonesian company law, from the perspective of creditor protection, there is an obligation to accumulate Legal Capital Surplus up to 20% of Legal Capital (in Japan, the combined total of Legal Capital Surplus and Retained Earnings must reach 25% of Legal Capital).
Japan is said to be experiencing a deflationary recession, a state where companies hold excess internal reserves without injecting money into the market, resulting in stagnant wages and prices.
Prime Minister Abe’s Liberal Democratic Party administration set an inflation target of 2% through the Bank of Japan to overcome the deflationary mindset. This was precisely to encourage the release of internal reserves (Legal Capital Surplus and Retained Earnings in accounting terms), raise prices, boost consumer spending, increase sales, improve corporate sentiment, and create a cycle where companies borrow money.
Indeed, if liquid assets accumulated in companies due to investment restraint and wage freezes during the "lost decade," it might be possible to "release internal reserves" by raising wages. However, companies have endured bad economic conditions by keeping wages flat, so the idea of raising wages to improve the economy doesn’t quite resonate.
Moreover, even if there were cash reserves for this purpose, the net profit for the period belongs to investors. Management cannot arbitrarily use it to fund wage increases without approval from shareholders at a general meeting.
There are three types of people involved in a corporation:

There are four ways to handle the resulting profits, but how management actually handles them is something investors can influence at the shareholders’ meeting:

Since internal reserves are not necessarily held as cash or deposits, whether "releasing internal reserves" is feasible depends on the company’s financial situation.
For example, a printing company that invested its 1 million yen deposit in an additional 5 million yen printing machine might have internal reserves on its financial statements but zero cash.
B/S after continued investment in printing machines:

Purchasing an additional printing machine for 5 million yen:

In accounting terms, transfer entries occur each month if profit appropriation is performed, but in an accounting system, this isn’t something you need to consciously manage. At the annual closing, the system automatically transfers the amount to the target net assets account (Retained Earnings), and entries are created for processes like allocating accumulated internal reserves to dividends.

In Indonesia, it’s rare to appropriate net profit for the month at each month-end closing; if it happens, it’s typically done at quarterly closings. Before reaching the final Retained Earnings (Carried-Forward Retained Earnings) on the B/S, temporary profit/loss accounts are used monthly or periodically.

Eliminating Cumulative Losses

If production actuals are not correctly entered into the system or month-end inventory counts are inaccurate, monthly inventory differences fluctuate significantly. A negative inventory difference increases manufacturing costs (or COGS for finished goods), resulting in a loss, while a positive difference reduces manufacturing costs (or COGS), resulting in a gain.
Since the system operates in a logical realm, inventory differences are reflected as inventory shrinkage costs (selling & administrative expenses) in COGS, directly impacting the P/L. Instead of expensing monthly losses from inventory differences, booking them as another asset can "hide input errors" (not losses), temporarily improving the appearance of the B/S and P/L.
Possible methods for handling inventory differences include:

Ideally, when inventory differences occur, you’d trace receipt/issue actuals, correct the data, apply method 1 to minimize expensing differences, and record negative Retained Earnings for losses using method 2. However, if this is labor-intensive, the system allows temporarily transferring losses to method 3 for later processing.
Ultimately, some form of transfer to an account is necessary, likely requiring a capital reduction to restructure the B/S.
Cumulative losses accumulate negatively in Retained Earnings, so if Assets – Liabilities = Net Assets is negative, it indicates insolvency. However, banks may still lend, and stock prices may rise due to:

Thus, it’s not necessarily dire to have cumulative losses.

Significance of Transferring Beginning and Ending Inventory at Closing

In closing entries, all monthly expense and revenue accounts are transferred to the profit/loss account, with two types of expenses targeted:

The balances of the Opening Stock, Closing Stock, and Purchase accounts are zeroed out on the P/L, replaced by the difference recorded as the COGS account balance (expense for sold items).

This completes the preparation for transferring expense accounts to the profit/loss account.

Net Profit Transferred to Retained Earnings Does Not Remain as Cash or Deposits

After month-end closing, the profit/loss on the P/L is recorded as is on the B/S under the profit/loss account (Net Profit). At the annual profit appropriation, it is either distributed as dividends or retained as Retained Earnings.
In system accounting, figures aggregated from journal entries recorded in the General Ledger (G/L) are pasted into pre-prepared formats to create the P/L and B/S. In bookkeeping terms, all monthly expense and revenue accounts are transferred to the profit/loss account.

Companies expecting growth bolster internal reserves for reinvestment in fixed assets like equipment, rather than returning profits to shareholders via dividends.

Transferring profit/loss to Retained Earnings increases net assets, but the accounts receivable, the substance of revenue, eventually become cash or deposits. The balance decreases due to capital expenditures or loan repayments, independent of the net assets’ movements.

A few years ago, in response to the opinion in Japan that "corporate internal reserves should be released to end deflation," the counterargument was, "Internal reserves are not necessarily held as cash or deposits," and this is why.

Methods of Profit Appropriation

Net assets are presented on the B/S as Legal Capital, Legal Capital Surplus, or Retained Earnings (Earned Surplus). Legal Capital Surplus and Retained Earnings constitute internal reserves, and under Indonesian company law, Legal Capital Surplus must be accumulated up to 20% of Legal Capital for creditor protection.
Dividends to shareholders as part of profit appropriation are sourced from Retained Earnings and recorded as a liability under unpaid dividends.