Retained earnings are that portion of profit not paid out as dividends.
Retained earnings are cumulative and represent both past & present earnings of an entity that have been reinvested. Thus it is important to realise that retained earnings does not represent surplus or leftover cash after the payment of dividends. Instead, retained earnings represent what an entity has reinvested in itself since inception. Retained earnings will be applied to either the purchase of an asset or the reduction of a liability.
Thus retained earnings are often used by an entity to reinvest in such matters as plant & equipment, for research & development or to retire debt.
Retained earnings are accounted for at the end of a financial year and can be either positive or negative earnings. Thus an increase or decrease in retained earnings during an accounting period is directly related to the amount of net income or net loss plus dividend payments for that accounting period.
When accounting for retained earnings, the closing balance at the end of an accounting period becomes the opening balance of retained earnings in next accounting period to which is added the net income or net loss for that accounting period against which is deducted any dividends paid in that accounting period.
Retained earnings are reported in the shareholders equity section of a balance sheet.
For an entity, when retained earnings increase so does shareholders equity which in turn increases the value of the individual shareholdings.
Please note: Prepared by Leigh Barker Tangible Assets, Accountant at MWC Group, Portfolio Finance, Gordon and West Pennant Hills. Note that all content of this blog is general in nature and anyone intending to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the information’s applicability to their particular circumstance.