University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

376

Pages:

2
Author:

stud_ice13

Key Components of Retained Earnings Retained earnings represent the cumulative total of a company’s net income or loss over time, less any dividends distributed to shareholders. It is reported on the balance sheet as part of stockholders’ equity and does not necessarily correlate with available cash. 1. Main Components of Retained Earnings: • • Net Income or Loss: Net income increases retained earnings, while net losses decrease it. This balance accumulates over time, providing a historical snapshot of earnings retained in the business. Dividends: Cash or stock dividends declared reduce retained earnings as they represent a distribution of profits back to shareholders. 2. Restrictions and Appropriations: • • Restricted Retained Earnings: Some portions of retained earnings may be restricted by law or contract. Common examples include: o Statutory Restrictions: Legal limitations on actions like buying back treasury stock, often tied to the balance in retained earnings. o Contractual Restrictions: Often found in loan agreements, limiting dividend payouts to ensure enough funds are retained within the business. Appropriated Retained Earnings: Management may voluntarily allocate a portion of retained earnings for specific purposes, such as future expansions or projects. These amounts are then reported in an Appropriated Retained Earnings account to signal to stakeholders that these funds are earmarked. 3. Prior Period Adjustments: • • • Definition: Corrections of material errors in past financial statements, such as significant math mistakes, misapplications of accounting principles, or overlooked information. Reporting: Prior period adjustments are made directly to the beginning balance of retained earnings in the statement of retained earnings, with any income tax effects included. Example: If a company erroneously expensed the purchase of land, correcting this mistake in a later period would involve a prior period adjustment to retained earnings, adjusting the balance to reflect accurate historical data. 4. Accounting for Estimates vs. Errors: • Changes in Accounting Estimates: Adjustments to estimates (like depreciation) based on new information are not errors and do not affect prior • retained earnings. Instead, they are accounted for in the current and future periods. Errors vs. Estimates: Errors lead to prior period adjustments, while revised estimates affect only the period of change and future periods. 5. Statement of Stockholders’ Equity: • • Purpose: This comprehensive statement reports the beginning and ending balances of retained earnings, common stock, additional paid-in capital, and other equity accounts. Structure: It shows all changes in each equity component over the reporting period, including impacts from net income, dividends, stock issuances, buybacks, prior period adjustments, and appropriations. This outline of retained earnings clarifies its role in tracking accumulated profits (or losses) and adjustments over time, including restrictions, appropriations, and the correction of past financial statement errors.