Question

How is net income connected to retained earnings and how does the Statement of Retained Earnings help the reader of financial statements understand a company’s past performance? What could you conclude about a company who ended their 3^rd year of operations with a Net Loss of $20,000 but that has an ending balance in retained earnings of $50,000? Describe a scenario that could explain how these results are possible

Answer 1

Net Income:

Net Income is the amount remaining after all expenses are deducted from revenue of the organisation.It is that portion of revenue which we maybe called Profit of an organisation.

Retained Earnings:

Retained earnings is the amount of net income left over for the business after it has paid out dividends to its shareholders.

After calculationg the Net Income, the balance left in Net Income after deducting dividend from it is transferred to Retained Earnings.Hence, when the profit increase the balance of retained earnings also increase and also negative net income decreased balances of retained earnings.Retained earnings is generally accumulated Net Income for many years.It shows how much company has earned during the past.If the balance in retained earnings is comparatively greater, then we can say that the company has a good past record and it has earned a very good amount of profits.Also if company has suffered losses in past then it more likely will have negative balance in retained earnings.

Now let's talk about the example given in question, it says company has suffered loss of $20000 still it has balance of $50000 in retained earnings.This may due to at the beginning of 3rd year retained earnings has balance of $70000 and due to negative income of $20000 it has come down to $50000.

This shows us how net income affect the balance of retained earnings.