Question

I still don’t understand what the Statement of Retained Earnings is all about and why do I need it. What is retained earnings? What is that thing called a dividend? Is it an expense?

Answer 1

Answer

• If speaking in a general term, Retained Earnings balance is the accumulation of past Net Income (loss).
• Retained Earnings is an EQUITY account having a normal credit balance.
• To update this balance, that is, to calculate the ending balance of Retained Earnings, the Statement of Retained earnings is prepared.
• Hence, Statement of Retained earnings is:
  --a statement prepared for calculating updated ending balance of Retained Earnings.
  --a statement where beginning retained earnings balance is increased by Net Income, and decreased by Net Loss and Dividends.
  --It is required to be prepared because Retained Earnings balance is required to be mentioned in Balance Sheet under “ Stockholder’s Equity” Section.
• As mentioned earlier, Retained Earnings, as the name suggests, are the earnings of business that have been retained, that is to say that they are not yet distributed to stockholders. It’s the accumulated total of Net Income (Loss) of past years.
• DIVIDENDS:
  --Dividends are the part of Net Income that are distributed to the stockholders.
  --These are the earnings of stockholders.
  --Dividends cannot be termed as ‘expense’ although the treatment of the same is just like any other expense.
  --Dividends are appropriation of Net Income.
  --It is not an ‘expense’ because Expenses are first considered to calculate Net Income, while Dividend is paid out of Net Income.
  --Moreover, Expenses for a business is the expenditure done to run the business.
• Standard proforma of a Statement of Retained earnings:

Statement of Retained earnings
for the period ended ………
Beginning balance of Retained earnings		XXX
Add: Net Income (loss)	XX
Less: All dividends paid or declared	XX
Net Increase (decrease) during the period		XXX
Ending balance of retained earnings		XXX