The statement of retained earnings is the financial statement that reports the entity’s opening balance of retained earnings, dividend distributions, net income, and year-end balance of retained earnings at the end of the period.
This statement might also show the adjusting transactions made during the year and the effect on retained earnings. This statement tied the income statement and balance sheet through net income made during the year. The entity may not prepare this statement, but they may use the statement of change in equity and balance sheet instead.
Yet, some analysts may want to use this statement as they are more detailed about retained earnings than the statement of change in equity.
The above is the format of the statement of retained earnings. As you can see, at the first of this statement, there is the opening balance of accumulated earnings that was brought forward from the previous year’s accumulated earnings.
As you can see in the format above, the increasing or decreasing of retained earnings depends on two important elements.
First is the net profit that the entity made during the year. And second is the dividend declared by the entity that is approved by the board of directors as well as authority. It is important to note that we can deduct only the dividend that is declared by the entity. If the dividend is not declared yet, then the dividend should not be qualified for the deduction.
For the new startup company that grows, the management team might not decide to pay the dividend to the board of directors. This is because they want to use the surpluses fund for expanding the operating, improve broth people and machine capacity.
Increase branding and spending more on research and development is also important in this stage. These things are essential to the entity’s future growth and sustainability.
However, they might consider making dividend payments to the shareholders for the financially healthy entity based on their approval. This is part of the investment strategy that making dividend payments could retain the investors and attract more potential investors.
Retained earnings are the balance sheet items in the equity section. Just like equity and liabilities, it is increasing in credit and decreasing in debit. At the time, net income is the move to retained earning, we credit-earning and debit net income. This is for manual transactions.
However, earnings are automatically recording to statement of retained earnings, balance sheet, and statement of change in equity for the system.
As you can see in the example above, Construction Com Ltd had retained earnings amount of 100,000 USD at the beginning of the year 2018.
And during the year 2018, the company make another profit of 50,000 USD. This would increase the accumulated earnings to 150,000 USD. Yet, during the year board of directors have approved the dividend payments to shareholders amount to 70,000 USD.
This will reduce year-end retained earnings to 80,000 USD at the end of 2018. Because the dividend payment is bigger than the net profit, the year-end earnings are less than the opening balance.
Let assume that the payments are the same, but the net profit is 100,000 USD. Then retained earnings would be 130,000 USD which is higher than the opening balance.
As explained above, year-end accumulative earnings depend on these two factors. And sometimes, it turns negative when the entity doesn’t make profits or recently makes losses.
Retained earnings-related question and answer:
Are the retained earnings show in the income statement?
Retained earnings are the accumulation of accumulated net income since the company’s incorporate minus losses if any and dividend that the company declared to its shareholders. Retained earning is only present in the statement of retained earnings and the company’s balance sheet in the Equity section. It is not showing the income statement.
The company’s income statement presents three main elements of financial statements: revenues, expenses, and net profits or losses that the company generates or incurred during the period. The net profit or net losses that result from the income statement affect the retained earnings at the end of the period.
When will the retained earning the change from positive to negative?
The accumulation of net income that the company generates from the start of the operation until the end of the specific accounting period is called retained earnings. However, not every year does the company make a profit. Sometimes they make losses, and the company’s losses are probably smaller or more significant than the accumulated retained earnings.
If the losses incurring the current year or period are smaller than the accumulated income or retained earnings, then the company still retained the positive retained earnings. However, the company keeps making losses, then accumulated losses will turn the retained earning into a negative balance, typically called accumulated losses.