Chapter 4: Statement of Retained Earnings

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Retrained earnings are the company's undistributed profits over the existence of the company (i.e. dividends that have not been distributed). The statement of retained earnings shows changes in the company's retained earnings over a time period.

(1) Company X is formed in 1 Jan 2019. At the date of formation it has zero retained earnings since it hasn't had any income.

(2) Company X has $50k of net income over the year and pay a dividend of $20k to members. It's statement of retained earnings for the year now look as follows:

Statement of Retained Earnings
Retained Earnings 1/1/2019 $0
Net Income $50k
Dividends paid ($20k)
Retained Earnings 12/31/2019 $30k

(3) In 2020 Company X has net income of $70k and pays $20k in dividends. It's statement of retained earnings would now look as follows:

Statement of Retained Earnings
Retained Earnings 1/1/2020 $30k
Net Income $70k
Dividends paid ($20k)
Retained Earnings 12/31/2020 $80k

It's the bridge between the income statement and the balance sheet. It takes information from the income statement (to get $50k and $70k above) and provides information to the balance sheet. The steps are:
1. Prepare Income Statement for the year
2. Use the Net Income from step 1 to prepare the statement of retained earnings
3. Use the retained earnings balance from step 2 to prepare the end of year balance sheet

  • Dividends show up on the statement of retained earnings -- they are not an expense and do not show up on the income statement
  • It's also not the same as cash -- profits may not have been distributed but they may have been spent in buying more inventory or invested in growing the company

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  • 10 months ago by vince