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Chapter 4 - Statement of Retained Earnings EXPLAINED! - YouTube
Channel: Else Grech Accounting
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I else here and in this video we'll be
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exploring the statement of retained
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earnings first let's remind ourselves of
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the proper order of the financial
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statements the income statement comes
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first the profit or net loss if expenses
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are greater than revenues is a measure
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of a business's performance we covered
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the single step income statement in our
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last video next businesses must prepare
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a statement of retained earnings this
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statement reports how profits and
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dividends have affected equity it is
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used because the majority of changes in
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equity are due to the generation and
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distribution of profit earned by the
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business information from this statement
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helps stakeholders assess of businesses
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use of profit
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how much is retained by the business for
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future growth and how much is paid out
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to the owners in order to understand the
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statement of retained earnings we must
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first understand what makes up the
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element equity equity is a difficult
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concept to grasp so we're going to keep
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it simple right now equity is equal to
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the wealth that is due to the owners of
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the business and is made up of two items
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first equity is the investment owners
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make in the business it represents the
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amount of cash goods or services a
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business receives from the owners in
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exchange for their share of the business
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for instance if you start a business
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with $20,000 of your own cash then you
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have $20,000 of capital in the business
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which would be recorded as equity second
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equity is the profit that the business
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generates and keeps in the business for
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instance if the business had profit of
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$10,000 during the year then the equity
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would go up by $10,000 if a portion of
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that profit was paid out to the owners
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in the form of dividends then equity
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would go up by the amount of profit and
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then down by the amount of dividends
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dividends are the profit which a
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business chooses to pay out to the
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owners of that business for example if a
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business had profit of $10,000 but paid
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out dividends of $2,000 then equity
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would increase by a net
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of $8,000 which are the profits that the
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business kept this is called retained
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earnings meaning the profit or earnings
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kept or retained in the business so to
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summarize equity is the capital invested
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by the owners plus the profit less the
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dividends retained by the business
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equity is owed to the owners of a
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business by the business equity capital
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plus retained earnings owed to the
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owners the statement of retained
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earnings focuses on how the retained
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earnings component of equity is
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determined let's take a look at the
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structure of this statement as always
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the statement starts with the heading
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which must include the business name the
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title of the financial statement and
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similar to the income statement the time
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period covered the body of the statement
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always starts with the beginning or
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opening balance of retained earnings
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this balance is always the closing or
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ending balance from the prior period
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statement of retained earnings think
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about opening retained earnings the way
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you would about the balance in your bank
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account the balancing your account at
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the end of one day say December 31st is
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the opening balance in your bank account
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the very next morning on January first
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opening retained earnings is exactly the
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same the ending balance on December 31st
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in one period would be the opening
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balance on January 1st in the next
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period note that if a business has just
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started the opening balance would be
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zero since they have never been in
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business before in the example we're
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using in this video the profit from all
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prior periods less the dividends paid
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out in all prior periods is equal to
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ninety two thousand four hundred dollars
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next the profit from the income
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statement is added to the beginning
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balance from retained earnings if the
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business has a net loss it would reduce
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the prior year's retained earnings
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balance in this case we have a profit so
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we would add seventeen thousand one
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hundred dollars to the opening balance
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of ninety two thousand four hundred note
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that the amount seventeen thousand one
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hundred dollars is from the income
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statement in our last video this shows
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the connection between the two
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statements
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profit from the income statement is used
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to calculate retained earnings next we
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have to deduct the dividends paid to the
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owners dividends are a distribution of
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the wealth to the owners by the business
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remember that the wealth of a business
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made up of owners capital and retained
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earnings is owed to the owners by paying
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out dividends the business is reducing
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retained earnings and by extension
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equity what is owed to the owners is
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therefore decreased the total at the
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bottom of the statement is the ending
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retained earnings the amount that will
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be transferred to the equity section of
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the balance sheet
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pretty simple statement but important to
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understand let's just summarize what we
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learned the opening balance for retained
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earnings comes from the prior year's
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statement of retained earnings profit
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comes from the bottom of the income
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statement dividends are what has been
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paid to the owners of the business a
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distribution of wealth the ending
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balance is the amount that will be
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carried to the equity section of the
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balance sheet this amount will also
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become the opening balance at the top of
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the statement of retained earnings next
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period pause the video to answer this
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check your understanding question what
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would be the businesses ending retained
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earnings given the amounts provided
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a is incorrect you remember the opening
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balance revenues and expenses but you
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forgot to deduct the dividends C is
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incorrect because it includes the
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contribution by owners which is part of
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equity but definitely not part of
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retained earnings D is incorrect because
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you deducted expenses but you added in
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the dividends when you should have
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subtracted them B is the correct answer
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because it includes only the opening
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retained earnings plus the revenues less
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the expenses and less the dividends paid
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how do stakeholders use the statement of
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retained earnings owners use information
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about retained earnings to help predict
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future dividend payments they also use
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it to see if the business is retaining
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enough of their profit for future
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expansion lenders such as banks use it
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to determine if dividend payouts are
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appropriate and leave enough cash for
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debt repayment other creditors use
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retained earnings information to see if
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the earnings are invested back into the
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business's future as you already know
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the statement of retained earnings is
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connected to the balance sheet providing
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the ending balance in retained earnings
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which is then used in the equity section
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of the balance sheet which is the topic
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of our next video
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