Accounting Basics: What are Retained Earnings?
Are you a Canadian business owner wondering, what are retained earnings? Here’s a quick refresher course.
Do you want to find out how you can prepare a retained earnings statement? If the answer is yes, this article is a must-read for you. Here’s an introduction of where retained earnings in accounting apply (especially when you’re preparing financial statements), as well as some insights into what retained earnings are and how they are calculated.
When preparing a company’s financial statements, two types of accounts are essential — first, the balance sheet accounts and next, the income statement accounts. Overall, the former reflects a company’s shareholder equity, assets, and liabilities. While the later demonstrates a company’s income and expenses, besides the profit for the reporting period.
As a crucial component of the shareholder’s equity segment, you can calculate retained earnings in a separate report known as the statement of retained earnings. You can prepare this file as a standalone document, but most companies append it at the bottom of the balance sheet.
In brief, the statement of retained earnings reconciles changes in the company’s retained earnings within the reporting period, making it a crucial accounting document.
What are retained earnings?
Retained earnings in accounting refer to the amount of profit a company has left—after deducting income taxes, direct costs, indirect costs, and dividends. Subsequently, you should transfer a firm’s annual revenues to the retained earnings account, and then, add them to the preceding year’s ending balance. From there, deduct dividends paid during the year. Eventually, what you remain with is the retained earnings balance.
Companies often reinvest the retained earnings into the business for new equipment, marketing, research, and development or as working capital. Retained earnings that accumulate recurrently depict the accrued profits. If a company experiences a loss during the year, the cost is transferred to retained earnings, thereby diminishing them.
A company can report negative retained earnings. In this case, it means the company has been using debt or shareholder capital for operations. And this can cause financial difficulties in the long run.
How do you prepare a retained earnings statement?
Preparing a retained earnings statement is easy. The company’s name appears at the top, followed by the phrase “statement of retained earnings” and the date. Subsequently, you present the calculations and display the result at the bottom. Information contained in the retained earnings statement is a measure of a company’s financial condition.
Equally, it can also be an indicator of the company’s management style. Ultimately, a firm with huge retained earnings often outlines good financial health since it has probably used its annual profits to buy assets.
While large retained earnings in accounting are generally a good thing, you should weigh them in the general context and nature of a company’s business. Different types of business ventures will perform differently, and for some (like start-ups), they might experience negative retained earnings at the beginning.
If you are seeking an experienced accounting partner to help you take your business to the next level, contact us.
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