Question

QUESTION 4 Problem 4-Statement of Retained Earnings Jason Woo Corporation began operations on January 1, 2017. During its first 3 years of operations, Woo reported net income and declared dividends as follows. Net income 2017 $160,000 2018 500,000 2019 740,000 Dividends declared $ 0 100,000 200,000 The following information relates to 2020 $960,000 $200,000 Income before income tax Prior period adjustment: understatement of 2015 depreciation expense (before taxes) Cumulative increase in income from change in inventory methods (before taxes) Dividends declared (of this amount, $100,000 will be paid on Jan. 15, 2021) Effective tax rate $240,000 $400,000 40% Instructions: Prepare a 2020 retained earnings statement for Jason Woo Corporation.
prepare a 2020 retained earnings statement for jason woo corporation

Answer 1

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Let's divide the answer into 2 parts :

1. Explanation on what is Retained earnings
2. Solution to the question.

Part 1: Explanation of what is Retained earnings

In simple terms, Retained earnings are the amount of profit after paying dividends.

For example, you if you run a Business, and you earn $100 profit after all expenses in 1st year and paid $20 as dividends to people who invested in your business(Shareholders), then your retained earnings (i.e balance of profits available with you after reducing expenses) is $100 - $ 20 = $80 in the 1st year. This $80 would become the opening balance for 2nd year.

The solution to the question:

Step 1: Calculation of opening Retained earnings balance as on 1st Jan 2020
Year	Opening Retained earnings **	Net income	Dividends	Closing Retained earnings
	A	B	C	[A+B-C]
2017	-	160,000	0	160,000
2018	160,000	500,000	100000	560,000
2019	560,000	740,000	200000	1,100,000
1. For the year 2017- There would not be any opening retained earnings since the company newly started its operations.
2. For the year 2018 & 2019-Opening balance of retained earnings is the closing balance of the previous year.

Step 2:

Statement of Retained Earnings for the year 2020
Particulars	Calculation	$
Opening balance as on 1st Januray 2020(from step 1)	[A]	1,100,000
Net income/(loss) for the year 2020	From Working note below [B]	616,000
Dividend expense for the year 2020 **	From Question [C]	(400,000)
Closing balance as on 1st Januray 2020 (from step 1)	A+B-C	1,316,000

** Dividend expense that is payable on 15th Jan 2021 i.e after year-end has to be reduced from year 2020 Profits since it pertains to 2020 Dividend expense.

[The journal entry would be: (for your understanding not the answer to given question.)

Dividend expense Dr

To Bank (for dividend paid) Cr

To Dividend payable( to be classified as liability in year 2020 Balance sheet) Cr]

Working note : Income for the Current year 2020
Particulars	Calculation	$
Income before taxes	A	960,000
Less: Taxes @ 40%	A x 40% = B	(384,000)
Income after taxes	A - B = C	576,000
Less: Understatement of Depreciation expense during 2015	D	(200,000)
Add: Cumulative change in income due to change in inventory methods	E	240,000
Net income for the year 2020	F= C-D+E	616,000