| Lesson 6 | The Statement of Retained Earnings |
Today Carl creates a statement of retained earnings.
Carl, proud owner of Carl’s Clockworks, now has a pretty good feel for the three main financial statements: the balance sheet, the income statement, and the statement of cash flows. He isn’t an expert on them, but he knows what they are and he has a basic understanding of what goes on them. Carl has heard that there is a financial statement known as the statement of retained earnings. The statement of retained earnings isn’t required, but Carl wants to learn more about it because his accounting friend, Peter, said it will help him understand net income, dividends, and owners’ equity much better.
Statement of Retained Earnings Example and Basics
If you get confused by accounting when you are learning a term, it always helps to read the term slowly (most accounting terms are very descriptive). The statement of retained earnings is simply a statement that lists, well, the retained earnings of the business. Remember that retained earnings are simply the earnings (or net income) that the company decides to reinvest. A company that has positive income or earnings can either withdraw those earnings and use the money for personal use (dividends) or put the money back into the business (retained earnings).
Let’s take a look at Carl’s Clockworks’ statement of retained earnings.
Carl didn’t have any retained earnings at the beginning of this year because he just barely started his business this year (otherwise he would have rolled over the amount from the previous year). Carl’s Clockworks’ net income for the year was $2,000 (he had $7,000 in revenue and $5,000 in cost of goods sold). During the year Carl decided to take out $1,000 in dividends (to purchase a new personal TV). That means that Carl is left with $1,000 in retained earnings. This is money that Carl is reinvesting into his business to help it grow.
That’s it for today Carl. This lesson is pretty brief. There really isn’t a lot to the statement of retained earnings. The general idea is that you follow this equation: (Ending retained earnings) = (Beginning retained earnings) + (Net Income) – (Dividends). Hold on tight because in the next lesson Carl will see how all the financial statements interact with each other.
Next Lesson: Lesson 7 – How the Financial Statements Interact
Return Home: The ClockWork Accounting School
