Accounting courses are intended for people who want to learn basic or intermediate accounting. One of the topics which is covered in this article is a relationship between Balance Sheet and Retained Earnings (RE) , covering concept of accumulated profit or loss and how it is related to one of the main financial statements. Also in this article you can explore practical example of this relation.
Considering the concept of Retained Earnings, it is understood as profit accrued by the business starting from its operations and not distributed to the shareholders as dividends. This amount can also be negative, if the business has accumulated loss which was not covered by the investments from the shareholders.
Retained Earnings is a part of Equity in the Balance Sheet on the side of Liabilities and Shareholders' Equity. To calculate this balance we start from the Income Statement, where Net Profit for the period is reported and if it is not distributed to the shareholders as dividends, this amount increases RE balance. If in the Income Statement we have a negative amount (ie net loss) it decrees Retained Earnings amount in the Balance Sheet.
In case part of the Net Profit for the period is distributed as dividends to the shareholders, only remaining amount increases RE.
To demonstrate the above relation, below there is a simplified Income Statement for the first year of business operations:
Revenue ______________ $ 15,000
Expenses ______________ $ 9,560
Net Profit ______________ $ 5,440
Net Profit amounting to $ 5,440 is included into the Balance Sheet as of year end, which is presented below:
Assets ______________ $ 32000
Liabilities & Shareholders' Equity
Liabilities __________ $ 6,560
Share Capital ____________ $ 20000
Retained Earnings ________ $ 5,440
Total Shareholders Equity __ $ 25,440
Total Liabilities & Equity __ $ 32,000
From the above you can see that all the amount of Net Profit ($ 5,440) since it was not distributed as dividends is included into the RE caption under Equity in the Balance Sheet.