Statement of Retained Earnings: Definition, Formula & Example

Lesson Transcript
Instructor
Anthony Aparicio

Tony taught Business and Aeronautics courses for eight years; he holds a Master's degree in Management and is completing a PhD in Organizational Psychology

Expert Contributor
Steven Scalia

Steven completed a Graduate Degree is Chartered Accountancy at Concordia University. He has performed as Teacher's Assistant and Assistant Lecturer in University.

Retained earnings are the amount of net income that a company keeps after making adjustments and paying any cash dividends to investors. Learn more about the definition and formula and see some examples. Updated: 10/11/2021

Discovering Retained Earnings

What exactly are retained earnings? They are the amount of income after expenses (or net income) that is not given out to stockholders in the form of dividends. Retained earnings are added to the owner's or stockholders' equity account depending on the type of organization.

Companies use retained earnings to fund ways in which they can grow, be more efficient, or contribute to the mission of the organization. It is important to note that retained earnings are not the same as cash. For example, IBM Corporation had $130 billion in retained earnings in 2013 but had under $11 billion in cash and cash equivalents. Retained earnings are cumulative profits over the course of a company's lifetime and are usually updated at the end of each year using the statement of retained earnings.

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Statement of Retained Earnings

After the organization's accounting team has completed the closing process and totaled all forms of income and expenses, the ending balances are posted to the retained earnings account. After this has been accomplished, you will have all the information you need in order to start on the statement of retained earnings.

Formula

There are two versions of the formula used to compute retained earnings. The simple formula to compute retained earnings is:

Beginning retained earnings + net income - dividends

However, to fully ensure the most accurate ending balance in the retained earnings account, bookkeepers must do all of the following:

Start with retained earnings last period balance (unadjusted beginning balance). Then, add or subtract prior period adjustments, which equals the adjusted beginning balance. From there, add the net income or subtract net loss, subtract cash dividends given to stockholders. This will give you the retained earnings ending balance.

The full statement of retained earnings will look like this:

Statement of Retained Earnings

Uses for the Statement of Retained Earnings

Not only is this another financial statement for investors and managers to gain better insight into the company's performance, but it's also used to ensure that the company is not violating any laws. Consider instances when companies purchase shares of their own stock into their treasury.

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Additional Activities

Preparing A Statement Of Retained Earnings - A Business Case:

The business case below, in which you will play the role of an experienced accountant mentoring an intern, will allow you to apply your knowledge about the preparation of the Statement Of Retained Earnings.

It is January 18th, 2020 and the accounting department at ABC Inc. is hard at work preparing the financial statements for fiscal year 2019. The company has hired interns to help with the reporting process and you are mentoring Kayla, an intern in her 2nd undergraduate year. Kayla was asked to prepare a preliminary Statement Of Retained Earnings since all the other accountants are very busy and she wanted you to review her work, point out any errors and, if necessary, prepare a revised Statement Of Retained Earnings. The company has a December 31st year end. All of the amounts used by Kayla were obtained from the latest adjusted trial balance. Kayla's work is below.

Statement Of Retained Earnings
For the year ended December 31, 2019
ABC Inc.
Item$
Retained Earnings Balance, Dec 31, 2018103,504
Adjustments
Correction for overstated interest expense in 2018(2,104)
Net income23,050
Dividend revenue4,250
Dividends declared6,508
Retained Earnings Balance, Dec 31, 2018 =103,504-2,104+23,050+4,250+6,508135,208

Solution:

See below.

Statement Of Retained Earnings
For the year ended December 31, 2019
ABC Inc.
Item$
Retained Earnings Balance, Dec 31, 2018103,504
Adjustments
Correction for overstated interest expense in 20182,104 (Note 1)
Net income23,050
Dividend revenueNIL(Note 2)
Dividends declared(6,508) (Note 3)
Retained Earnings Balance, Dec 31, 2018 =103,504+2,104+23,050-6,508122,150

Note 1:

  • If interest expense was overstated, this means that income was understated in 2018. In order to adjust the retained earnings balance, we must add to the beginning balance since the 2018 net income was understated.

Note 2:

  • Dividend revenue is already included in net income and thus should not be added to retained earnings (It would double-count the dividend revenue).

Note 3:

  • Dividends declared must be subtracted from retained earnings, not added.

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