How to Prepare a Statement of Retained Earnings

A Statement of Retained Earnings tracks changes in a company’s accumulated profits over an accounting period. It bridges a company’s Income Statement and Balance Sheet, showing how net income and dividend distributions affect the equity section. This statement helps stakeholders understand how a business utilizes its earnings, whether by reinvesting them for growth or distributing them to owners. Its primary purpose is to provide clarity on how profits are managed and allocated.

Key Elements of the Statement

The Statement of Retained Earnings illustrates the movement of accumulated earnings. It starts with the retained earnings balance from the previous accounting period, which acts as the foundation for the current period’s activity. This initial figure represents all profits a company has accumulated and kept since its inception, after any distributions.

Next, the company’s net income or net loss for the current period is incorporated. Net income, representing profit earned after all expenses are deducted, increases retained earnings. Conversely, a net loss reduces retained earnings.

Dividends declared and paid to shareholders during the period also impact retained earnings. Dividends represent a portion of profits distributed to owners, and their payment reduces the retained earnings balance. These distributions can be in cash.

Finally, certain adjustments for prior periods might be necessary to correct errors or reflect changes in accounting principles. These adjustments can either increase or decrease the retained earnings balance.

Constructing the Statement

Preparing a Statement of Retained Earnings involves a straightforward calculation. The process begins by identifying the retained earnings balance from the conclusion of the prior reporting period, which becomes the starting point for the current statement.

Following the beginning balance, the net income for the current period is added. If the company experienced a net loss, that amount would be subtracted instead. This addition or subtraction reflects the impact of the company’s operational performance on its accumulated earnings.

Subsequently, any dividends declared and paid to shareholders during the period are subtracted from the running total. This step accounts for the portion of profits that has been distributed to owners rather than retained within the business. The decision to pay dividends often balances rewarding shareholders with reinvesting for future growth.

The basic formula for this calculation is: Beginning Retained Earnings + Net Income (or – Net Loss) – Dividends = Ending Retained Earnings. For example, if a company began with $100,000 in retained earnings, earned $50,000 in net income, and paid $10,000 in dividends, its ending retained earnings would be $140,000. This ending balance then becomes the beginning balance for the subsequent period.

Connecting with Financial Records

The figures necessary to prepare the Statement of Retained Earnings are sourced directly from a company’s other primary financial statements and internal records. The beginning retained earnings balance, which initiates the statement, is found on the company’s Balance Sheet from the end of the previous accounting period. This ensures continuity and accuracy across reporting cycles.

The net income or net loss figure, a central component of the statement, is obtained directly from the company’s Income Statement for the current period. The Income Statement summarizes revenues and expenses, culminating in the net profit or loss that impacts retained earnings. This direct link highlights how current profitability flows into the company’s accumulated earnings.

Information regarding dividends declared and paid to shareholders is typically found in the company’s internal financial records, such as ledger accounts for dividends payable or cash disbursement records. While not always explicitly listed on the Income Statement or Balance Sheet, dividend payments are crucial for determining the final retained earnings balance. The ending retained earnings balance calculated on the Statement of Retained Earnings then reconciles with the retained earnings line item under the shareholders’ equity section of the current period’s Balance Sheet. This interconnectedness ensures that all financial statements present a cohesive and accurate picture of a company’s financial position and performance.