Statement of Retained Earnings: Definition, Formula & Example

Statement of Retained Earnings: Definition, Formula & Example
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  • 0:01 Discovering Retained Earnings
  • 0:52 Statement of Retained Earnings
  • 1:11 Formula
  • 1:55 Uses for the Statement…
  • 3:00 Lesson Summary
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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

Retained earnings are a critical part of the business life cycle. The statement of retained earnings calculates not only the cumulative amount of earnings but also the changes that have affected that amount during the past year.

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.

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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