How to Prepare a Retained Earnings Statement
Understand and prepare the retained earnings statement. Track how a company's accumulated profits are reinvested or distributed.
A retained earnings statement provides an overview of the changes in a company’s retained earnings over a specific accounting period, such as a month, quarter, or year. This financial document details how a business’s accumulated profits have been utilized or retained. It serves to bridge the financial performance shown on the income statement with the financial position reported on the balance sheet. Understanding this statement helps illustrate a company’s strategy regarding reinvestment of profits versus distribution to shareholders.
Elements of the Statement
The retained earnings statement is built upon several core components that reflect the movement of a company’s accumulated profits. It begins with the retained earnings balance from the prior accounting period, which represents the accumulated profits kept by the company since its inception. This opening figure sets the baseline for the current period’s changes.
Net income or net loss from the current reporting period is then factored into the statement. Net income, which is the profit remaining after all expenses are deducted from revenues, increases retained earnings, while a net loss reduces them.
Finally, dividends paid to shareholders are subtracted from the total. Dividends represent a portion of the company’s earnings distributed to its owners, and they can be in the form of cash or additional stock.
Sourcing the Data
Preparing a retained earnings statement requires obtaining specific financial figures from other primary financial documents and company records. The starting point, beginning retained earnings, is found directly on the balance sheet from the end of the previous accounting period. This amount is typically listed within the shareholders’ equity section. For a newly established company, the beginning retained earnings balance would be zero.
The net income or net loss figure for the current period is sourced directly from the company’s income statement. This “bottom line” result from the income statement is a direct input into the retained earnings calculation. It reflects the profitability of the business operations over the reporting period.
Information regarding dividends paid during the period, including both cash and stock dividends, is obtained from the company’s internal financial records. While the specific amounts may also appear on the statement of cash flows under financing activities for cash dividends, the company’s detailed dividend declarations and distributions provide the precise figures needed for this section of the statement.
Constructing the Statement
The construction of a retained earnings statement follows a standardized format. It begins by listing the beginning retained earnings balance for the period. This initial amount reflects the accumulated earnings carried over from the prior fiscal period.
Next, the net income for the current period is added to the beginning balance. If the company incurred a net loss during the period, this amount would instead be subtracted. This adjustment directly reflects the profitability or unprofitability of the business operations for the period in question.
Following this, any dividends paid out to shareholders during the period are subtracted. This includes both cash dividends, which represent direct cash payouts, and stock dividends, which involve distributing additional shares to existing shareholders. The reduction reflects the portion of earnings that has been distributed rather than retained.
The final calculation results in the ending retained earnings balance for the current period. This ending balance is then carried forward as the beginning retained earnings for the next accounting period. Adhering to Generally Accepted Accounting Principles (GAAP) is important for maintaining transparency and consistency in this process.
Statement Connections
The retained earnings statement serves as a bridge between a company’s income statement and its balance sheet, demonstrating how profits are managed within the business. The net income or net loss calculated on the income statement directly flows into the retained earnings statement, increasing or decreasing the retained earnings balance.
The ending retained earnings balance derived from this statement then directly transfers to the shareholders’ equity section of the balance sheet. This connection ensures that the balance sheet accurately reflects the cumulative earnings that the company has retained for reinvestment or future use.
Furthermore, the payment of dividends, a deduction on the retained earnings statement, has an impact on the statement of cash flows. Cash dividends paid to shareholders are recorded as a financing activity on the cash flow statement, reflecting the outflow of cash from the company.