Definition and explanation
The statement of retained earnings is a financial statement that summarizes the changes in the amount of retained earnings during a particular period of time.
Retained earnings is the portion of net income that a company does not distribute among its shareholders but retains in the business for various purposes such as growth of business in future and meeting the debt obligations etc. It increases when company earns net income and decreases when company incurs net loss or declares dividends during the period. Retained earnings appears in the balance sheet as a component of stockholders equity.
The statement of retained earnings is prepared after the preparation of income statement but before the preparation of balance sheet because it is used to compute the amount of retained earnings balance at the end of the period which is finally reported in the entity’s balance sheet.
The computation of retained earnings figure at the end of the period can be shown in the form of the following formula/equation:
Retained earnings at the end = Retained earnings at the beginning + Net income – Dividends
Format of the statement of retained earnings
A simple format of statement of retained earnings is given below:
In above format, the heading part of the statement is somewhat similar to that of an income statement. It consists of three lines. The first line exhibits the company name to which the statement belongs, the second line shows the statement name, which is obviously the statement of retained earnings, and the third one tells users about the time span for which the financial statements are being prepared. This time span may consist of a quarter, a six month period or a complete accounting year of the entity.
Notice that the content of the statement starts with the beginning balance of retained earnings. The net income is added to and the net loss is subtracted from the beginning balance, any dividends declared during the period (whether paid or not) is also subtracted in the statement of retained earnings. The resulting figure is the balance of retained earnings at the end of the period that should appear in stockholders’ equity section of the entity’s balance sheet.
The adjusted trial balance and the income statement of Business Consulting company are given in income statement article. Using that information, we can prepare the statement of retained earnings of the company as follows:
Notice that the opening balance of retained earnings account in above example is $20,000 which increases to $38,000 as a result of net income earned for the year 2015 and then reduces to $35,000 because of the distribution of $3,000 dividend. When Business Consulting Company will prepare its balance sheet, it will report this ending balance of $35,000 as part of stockholders’ equity. You can see this presentation in the format section of the next page of this chapter – the balance sheet.
Nova Electronics Company earned a net income of $1,500,000 for the year 2021. The retained earnings account balance as per adjusted trial balance of the company was $3,500,000. During the year Nova declared and paid a divided of $250,000 to its stockholders. On January 1, 2021, the company had 500,000 shares of $10 par value common stock and 50,000 shares of $100 par value preferred stock outstanding. The number of shares remained unchanged throughout the year as Nova did not make any new issue during 2021.
Required: Calculate the balance of retained earnings account that the company should report in its balance sheet as on December 31, 2021.