Is Retained Earning an Asset?
Retained Earnings is the net income which is accumulated over a period of time and later on used to pay shareholder in form of dividend or compensation to shareholders in case of selling or buying of the corporation. Thus, retained earnings are not an asset for the company since it belongs to shareholders. An Entity holds it as additional equity shareholder capital.
Net Retained Earnings = Retained Earnings at the beginning of the Period + Net Income/Loss During the Period – Total Dividends.
Basically, retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. shown in the liability side of the balance sheet is under the head reserves and surplusReserves And SurplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet. in shareholder’s equity fund. It is considered as an equity account; hence it is usually expected to have a credit balanceCredit BalanceCredit Balance is the capital amount that a company owes to its customers & it is reflected on the right side of the General Ledger Account. Usually, Liability accounts, Revenue accounts, Equity Accounts, Contra-Expense & Contra-Asset accounts tend to have the credit balance. .
Purpose of Retained Earnings
- For distribution of the dividend at any time in the future, i.e., in the middle of any financial year;
- These earnings are retained for future use to help in funding for an expansion of the corporation.
- One of its uses can be as compensation to the shareholders in case of winding up of a corporation.
- An entity can capitalize on the credit balance of the retained earnings by issuing bonus sharesBonus SharesBonus shares refer to the stocks issued by the companies for free of cost to their existing shareholders in the proportion of their stock holdings. Companies issue such shares to compensate the shareholders with a higher dividend payout in the form of stocks. to the shareholders.
Case #1: In case there is a net profit from profit and loss account for the relevant financial year
XYZ Corporation has retained earnings at the beginning of the period 2019 of $250,000. During the year company earns the net income of $100,000 after deducting all the expenses. It pays the preference dividend to preference shareholders of $75,000 and equity dividend to the equity shareholders of $100,000. Calculate the retained earnings of the company for the period ending in 2019.
Calculation of retained earnings of the company for the period ending in 2019:
Case #2: In case there is net loss from profit and loss account for the relevant financial year
ABC Corporation has retained earnings at the beginning of the period 2019 of $350,000. During the year company incurs the net loss of $120,000 after deducting all the expenses. Since there is a net lossNet LossNet loss or net operating loss refers to the excess of the expenses incurred over the income generated in a given accounting period. It is evaluated as the difference between revenues and expenses and recorded as a liability in the balance sheet. from profit and loss account, hence dividends to any shareholders will not be distributed. Calculate the retained earnings of the company for the period ending in 2019.
Calculation of Retained Earnings of the company for the period ending in 2019:
- Thus retained earnings are said to be part of net profit after deducting the dividend to be paid to the shareholders. It will accumulate over some time to utilize them for Future funding consequences, which may arrive in the corporation at any point in a future date.
- Retained earnings are the entity’s net income from various operations held by the company as additional equity shareholder capital. Hence it is considered as shareholders fund and also represents in calculating return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit. invested by the shareholders in the entity.
This article has been a guide to Is Retained Earning an Asset? Here we discuss the classification of retained earnings along with its purpose. You can learn more about from the following articles –