How to Prepare a Statement of Retained Earnings

A Statement of Retained Earnings details how a company’s accumulated earnings change over a specific period. It shows how profits are utilized, whether retained for reinvestment or distributed to shareholders. This statement bridges the gap between a company’s income statement and its balance sheet, illustrating the flow of earnings and their disposition. Understanding it helps stakeholders gauge a company’s financial health and strategy for managing profits.

Information Needed to Prepare the Statement

To construct a Statement of Retained Earnings, specific financial information must be gathered. This preparatory phase involves identifying three primary components that reflect the company’s financial activity during the accounting period. These components track the movement of earnings.

The first piece of information is the Beginning Retained Earnings Balance. This figure represents the cumulative net income that a company has accumulated and kept from prior accounting periods, not distributed as dividends. This balance is found on the balance sheet from the end of the previous reporting period, serving as the starting point for the current statement.

Next, the Net Income or Loss for the current accounting period is necessary. This figure is obtained from the company’s income statement. A net income indicates profit earned after all expenses, increasing the retained earnings, while a net loss reduces them. This inclusion highlights the profitability or unprofitability of the company’s operations during the period.

Finally, Dividends Declared during the period must be identified. Dividends are distributions of a company’s earnings to its shareholders, reducing retained earnings. This information is sourced from the company’s internal financial records or the cash flow statement. These payouts signify how much of the current or accumulated profits are returned to investors.

Steps to Construct the Statement

Once necessary financial information is gathered, the Statement of Retained Earnings can be constructed. The basic formula for calculating ending retained earnings is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. This equation captures the flow of earnings into and out of the company.

The process begins by taking the beginning retained earnings balance from the prior period. For example, if XYZ Corp. had a beginning retained earnings balance of $100,000 as of January 1, 2023, this is the initial figure. This balance forms the basis for the current period’s financial activities.

Then, the net income for the current period is added to this beginning balance. If XYZ Corp. reported a net income of $50,000 for the fiscal year ended December 31, 2023, this amount is added to the $100,000, resulting in a subtotal of $150,000. For a net loss, the amount is subtracted instead.

Finally, any dividends paid to shareholders during the period are subtracted. If XYZ Corp. paid out $10,000 in dividends, this amount is deducted from the $150,000 subtotal. The final calculation provides the ending retained earnings balance for the period, which in this example is $140,000 ($100,000 + $50,000 – $10,000). This ending balance becomes the beginning balance for the subsequent accounting period.

Key Elements of the Statement Presentation

The final Statement of Retained Earnings requires specific formatting and labeling. A three-line heading is standard, including the company’s name, the title “Statement of Retained Earnings,” and the specific accounting period covered (e.g., “For the Year Ended December 31, 20XX”). This ensures the statement’s context is immediately understood.

The statement lists the beginning retained earnings balance as the first line item. Subsequent lines show the addition of net income (or subtraction of net loss) and the deduction of dividends paid. Each component should be distinctly labeled to show how the ending balance is derived.

Proper currency notation (e.g., dollar signs) and clear formatting are important for readability. The ending balance of retained earnings is the final figure on the statement. This balance directly reconciles with the retained earnings line item in the shareholders’ equity section of the company’s balance sheet for the same period. This reconciliation demonstrates the interconnectedness of financial statements.