The Statement of Retained Earnings
The retained earnings statement is one of the four main financial statements and is the link between the income statement and the balance sheet.
To understand the retained earnings statement we first need to explain the meaning of retained earnings.
What is Retained Earnings?
Retained earnings refers to the net income retained by a business after any distribution (dividends) to the equity holders. In effect the net income is split between the amount paid out to equity holders and the amount retained within the business.
|Dividend||Retained earnings for the year|
Retained earnings is increased by net income and is reduced by dividends. The dividends are the amount which has been declared for the year not the amount paid during the year.
The retained earnings for each year accumulate on the Retained Earnings account which forms part of the owners equity in the balance sheet.
|Retained earnings Year 1||Retained earnings Year 2||Retained earnings Year 3|
|Retained earnings account balance|
This account forms part of the equity of the business, as it is retained in the business but belongs to the equity holders.
What is the Retained Earnings Statement for?
The purpose of the retained earnings statement is to reconcile the beginning and ending balances on the retained earnings account. The ending balance on the retained earnings account shown in the ending balance sheet, is given by the retained earnings equation
Statement of Retained Earnings Formula
The formula for retained earnings is as follows:
Retained Earnings Statement Sample
The statement of changes in retained earnings sample shown below is typical of how a business will present the balance of retained earnings.
|Beginning retained earnings||38,000|
|Plus: Net income||40,000|
|Ending retained earnings||68,000|
Is Retained Earnings Equity?
The net income of a business belongs to the owners, we have seen above that the net income can either be paid out to the owners by way of dividend, or kept within the business, as retained earnings. Either way, the net income and therefore the retained earnings, belongs to the owners and forms part of the owners equity.
The accounting equation tells us
The owners equity includes amounts invested by the owners (capital) and net income of the business which have been retained. The accounting equation can be re written
Retained Earnings Statement Example
As an example, suppose a business has net income for the year of 60,000 and declares a dividend of 10,000, and the balance on the retained earnings account at the beginning or the year was 20,000. The retained earnings are given by:
Retained earnings = Net income – Dividend = 60,000 – 10,000 = 50,000.
The net income has been split between 10,000 paid out to equity holders, and 50,000 retained within the business. The amount retained still belongs to the equity holders and forms part of the owners equity.
The ending balance on the retained earnings account will be:
Ending balance = Beginning balance + Retained for the year Ending balance = 20,000 + 50,000 = 70,000
The retained earnings statement will show:
|Beginning retained earnings||20,000|
|Plus: Net income||60,000|
|Ending retained earnings||70,000|