Question

1. Why do we need a statement of retained earnings? What does it tell stakeholders?

2. Temporary accounts, permanent accounts, closing them, not closing them, I'm confused. Explain this to me.

3. Why would a company WANT to have a high current ratio? What does it signify

Answer 1

1.Benefits of a Statement of Retained Earnings

The purpose of releasing a statement of retained earnings is to improve market and investor confidence in the organization. It is used as a marker to help analyze the health of a firm. Retained earnings do not represent surplus funds. Instead, the retained earnings are redirected, often as a reinvestment within the organization.

The retained earnings for a capital-intensive industry or a company in a growth period will generally be higher than some less-intensive or stable companies. This is due to the larger amount being redirected toward asset development. For example, a technology-based business may have higher asset development needs than a simple t-shirt manufacturer, as a result of the differences in the emphasis on new product development. While a t-shirt can remain essentially unchanged for a long period of time, a computer or smartphone requires more regular advancement to stay competitive within the market. Hence, the technology company will likely have higher retained earnings than the t-shirt manufacturer.

2.

i) Temporary Accounts – revenues, expenses, dividends (or withdrawals) account. These account balances do not roll over into the next period after closing. The closing process reduces revenue, expense, and dividends account balances (temporary accounts) to zero so they are ready to receive data for the next accounting period.

ii) Permanent accounts Also referred to as real accounts. Accounts that do not close at the end of the accounting year. The permanent accounts are all of the balance sheet accounts (asset accounts, liability accounts, owner's equity accounts) except for the owner's drawing account.

3. In many cases, a creditor would consider a high current ratio to be better than a low current ratio, because a high current ratio indicates that the company is more likely to pay the creditor back. ... A current ratio of less than 1 indicates that the company may have problems meeting its short-term obligations.