Retained earnings are what entity left from its operating profits since the beginning of the business until the reporting date. These amounts use for two main purposes: reinvestment or distribution to shareholders.
It has happened only if the entity makes a profit, and if it is operating loss, then not even dividends could not be distributed, an additional contribution from shareholders probably require by local authority and law.
For example, RealEst is the real estate company that runs the business is the town for three years and now the accumulated earnings reach 100,000 USD.
An entity may distribute a portion of this USD100K to shareholders or keep it there for expanding its operation. This is depending on management decisions.
Increasing and decreasing of retained earnings are caused by many different factors. Those key factors including Net income/ Net Loss, Dividend, Adjustments, and Interest Expenses.
At the time that entity starts its operation, normally it is hard to make a net operating profit. This is because not many sales are made during the first few years, but the entity normally incurs the large amounts of operating expenses including deprecation, staff, branding, marketing expenses, and other administrative costs.
These factors will lead to net losses and subsequently, make the negative retained earnings. A few years later, the entity might generate more sales and make its first breakeven. The bottom line might be changed from negative to positive.
At this time, entity retained earnings will positively increase. This is how net income cause accumulated earnings to increase or decrease.
The dividend payment sometimes happens during the year when an entity wants to make payment to its shareholders.
This payment is declared by the entity when it gets approval from the board of directors and local authority. If that is the case, then the retained earnings will reduce by the dividend amounts.
This is how the dividend makes retained earnings decrease. However, if the entity doesn’t want to make a dividend payment to its shareholders yet, the retained earnings will remain the same.
It is important to note that even though the dividend does not distribute yet during the year but the entity had declared the payment to shareholders, then the dividend still needs to accrual and deduct from retained earnings.
At that time, the dividend is the debit to retained earnings and credit to payable to shareholders.
Entity normally requires to have an audit of their financial statements annually by an independent auditor.
When performing an audit on entity financial statements, auditors might find some misstatements due to accounting treatments.
The adjustments to the misstatements that propose by auditors have sometimes affected the entity’s financial statements opening balance including retained earnings.
It is pending on the nature of adjustments whether they are positively or negatively affect the retained earnings. However, in most of the cases, adjustments would make retained earnings decrease.