How is retained earnings effect?
Many factors affect an entity’s retained earnings, and these effects could increase or decrease accordingly. The primary elements that affect retained earnings are net income/ net loss and dividend payments.
If the entity makes a lot of profit and subsequently net income, the earnings will eventually increase. Other factors that affect retained earnings are sales, cost of goods sold, interest expenses, and some adjustments that could affect the opening balance of retained earnings.
- Net income/ Net Loses is directly affect the entity’s retained earnings. Normally, net income or net loss is reporting in the entity income statement. Sometimes called the bottom line. If an entity makes operational profits, then the amounts it takes from the income statement to retained earnings statement will be big, and earnings will subsequently increase. Yet, if the entity does not make profit but adversely makes a loss, then the entity’s earnings will be reduced. Please noted that accumulated earnings are increasing credit and decreasing in debit.
- Dividend payments made during the year to the entity’s shareholders would make the accumulated earnings decrease. And when calculating year-end yet income, we must deduct the declared dividend payments amount from the calculation. The deduction can be before or after the addition of net income. If the declaration is not made and the board of directors and authority are not approved yet, the dividend is not qualified for the deduction.
Many other factors indirectly affect the entity’s retained earnings. Those factors also include the accounting adjustments that might happen when current year auditors recommend that the adjustment be made to the opening balance. The following are those factors:
- Sales growth is important that directly affects net income. If sales grow with a positive gross profit margin, then the entity would make profits. These factors significantly affect net income. It is also subsequently affects accumulated earnings.
- The cost of goods also sold directly affects net income, and if it increases or decreases consistently with sales, then net income will also increase or decrease and do so earnings.
- Interest expenses are depending on the entity’s financing strategy. Some entities may choose to finance their operation through loans, and some entities might choose to finance through equity. If the entity has financial leverage is highly on loan, then the entity will face high-interest expenses. This will affect retained earnings. And if the entity has less loan, then the entity will not be spending much on interest expenses, and the remaining will forwarding to accumulated earnings.
- Adjustments propose by current year auditors might also affect the opening balances. It depends on the nature of the adjustment, and if the adjustment is made, it affects the opening balance. Some of them might affect the opening balance of retained earnings.