What is the Statement of Retained Earnings?
Statement of retained earnings is a financial statement which shows how the retained earnings have changed during the financial period and provides details of beginning balance of retained earnings, ending balance and other information required for reconciliation.
- Retained Earnings is a part of the net income retained by the Company after dividend payment to the shareholders. Retained earnings are also called ‘retained surplus’ or ‘accumulated earnings.’
- A company retains a part of its net profit earned in the financial year for future growth, which could be by launching new products, R&D investments, acquisition of other businesses, or paying off its debt.
- Retained earnings are reported on the balance sheet as well as the statement of retained earnings.
Retained earnings after a given financial year are calculated as follows:
How to Prepare the Statement of Retained Earnings?
Given below are the steps for the preparation of Retained Earnings Statement.
Step 1 – Headings
Its’ heading comprises three lines:
- Name of the Company
- The second line gives the ‘Statement of retained earnings.’
- The third line represents the financial year for the retained earnings numbers that have been prepared, i.e., ‘Financial Year Ended 2018’ etc.
Step 2 – Retained Earnings Balance from the Previous Year
The first entry on the statement is the previous years carried over balance. This entry can be taken from the previous years’ balance sheet or the ending balance of previous years’ retained earnings. This is also called the beginning retained earnings.
Let us consider the previous years retained earnings balance or the beginning retained earnings of a Company ABC Inc. is $ 500000.
Thus, the first entry will be:
- Retained Earnings for the year ended 2017: $ 50000
Step 3 – Net Income Addition
Net Income is added from the income statement. It comes as the second entry to the retained earnings. To record net income to the statement, the Company should prepare the income statement first and then the retained earnings statement.
Let’s assume the Company ABC Inc. had a net income of $ 100000
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Thus, it will be
- Retained Earnings for the year ended 2017: $ 500000
- Plus, Net Income 2018: $ 100000
- Total: $ 600000
Step 4 – Subtract Dividend Payments
A dividend is any payment made by the Company to its shareholders. It is subtracted from the net income for the year, as the remaining part is the retained earnings for that year. Let us say the Company ABC Inc. paid a dividend of $ 50000 to the shareholders.
Thus, it is:
- Retained Earnings for the year ended 2017: $ 500000
- Plus, Net Income 2018: $ 100000
- Total: $ 600000
- Minus: Dividend $ 50000
Step 5 – Ending Retained Earnings
After subtracting the dividend from the net income, we arrive at the ending retained earnings, and that becomes the last entry to this Statement.
- Retained Earnings for the year ended 2017: $ 500000
- Plus, Net Income 2018: $ 100000
- Total: $ 600000
- Minus: Dividend $ 50000
- Ending retained earnings: $ 550000
Thus, the above entries are shown on the Statement of Retained Earnings.
Step 6 – Additional Information
Although, this statement is pretty straight forward; however, additional information can be provided in the footnotes to the statement. This additional information can provide details about the stock purchase, new issuance of stock or rights issue, etc. All, these corporate actions affect the dividend payment. Hence additional information can be provided to the investors.
Examples
Let’s see some examples so that you can understand this in a better manner.
Example 1
Let us summarise the above explain example and prepare the Statement of Retained Earnings for the Company ABC Inc. The beginning retained earnings of the Company ABC Inc. is $ 500000, the Company had net income of $ 100000 and paid a dividend of $ 50000 to the shareholders.
The Statement at the end of the financial year is as below:
Example 2 – (Apple Inc)
Below snapshot shows the Consolidated shareholder’s equity statement for Apple Inc. for the year ended 2018.
source: Apple SEC Filings
All figures below are in thousands.
- Apple’s Retained Earning in FY2015 = $92,284
- Net Income in FY 2016 = $45,687
- Dividends in FY 2016 = $12,188
- Buyback of common stock = $29,000
- Common stock issues (net of shares) = $419
Apple’s Retained Earnings in FY2016 = $92,284 + $45,687 – $12,188 – $29,000 -$419 = $96,364
Relevance and Uses
This statement is very helpful to investors. Investors who have invested in a Company gain either from dividend payments or the share price increase. A mature firm is expected to pay a regular dividend, whereas a growing Company is expected to retain the income and invest in future business, thus expecting an increase in the share price.
Hence, it helps investors in both ways:
- It shows dividend payment to the investors or helps investors to predict future dividend based on the earnings.
- From retained earnings, the investors can analyze how much money is reinvested in the business and may lead to a future increase in the share price.
Also, it can be used by investors to compare two Companies in similar kind of business. However, it is not always prudent to compare two Companies only based on the retained earnings as retained earnings depend on various factors like the age of the Company, dividend policy of the Company, and the nature of the business, thus affecting the profitability of the Company.
Conclusion
Retained earnings are the amount the Company has accumulated over the years from the net income after paying dividends to the shareholders. Retained earnings statement provides details of the beginning retained earnings, net income, dividend aid, and the ending balance of the retained earnings.
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