In: Accounting
The beginning balance of retained earnings plus net income (revenues less expenses), less dividends results in the ending balance of retained earnings. At September 1, 2014, Five-O Inc. reported retained earnings of $136,000. During the month, Five-O generated revenues of $20,000, incurred expenses of $12,000, purchased equipment for $5,000 and paid dividends of $2,000. What is the balance in retained earnings at September 30, 2014?
$8,000 credit
$137,000 credit
$142,000 credit
$136,000 debit
Calculation of balance in retained earnings at September 30. 2014
opening balance of retained earnings | $136,000 | |
ADD | Generated Revenues | $20,000 |
LESS | Incurred expenses | $12,000 |
LESS | Dividends paid | $2,000 |
Closing balance of retained earnings |
$142,000 |
Answer: $142,000 credit (Purchase of an equipment does not effect retained earnings)
for detailed explaination refer below
Retained earnings are an important part of any business's financial picture. Over the course of a year, retained earnings will increase and decrease. These fluctuations will be due primarily to one of three events in a business's cash flow: experiencing net gains, having net losses or paying out dividends. All these events will be documented in a business's accounting statement of retained earnings, which acts as a helpful indicator of a business's financial health.
Net Gains
Any event that impacts a business's income will, in turn, affect retained earnings. Retained earnings increase when a business receives income, whether through profits gained by providing customers a service or a product or through capital stock investments. Retained earnings carry over from the previous year if they are not exhausted and continue to be added to retained earnings statements in the future. For the most part, businesses rely on doing good business with their customers and clients to see retained earnings increase.
Net Losses
Events that cause a net loss in a business's cash flow will decrease retained earnings. This is usually the result of paying the costs of doing business. Overhead expenses such as rent, payroll and purchasing goods or supplies to provide services or products to customers are all things that will reduce retained earnings. Anything that deducts from a business's income or cash causes a resultant dip in retained earnings, even if the expenses are necessary to keep the business running.
Dividend Payments
Another thing that affects retained earnings is the payout of dividends to stockholders. Dividends are what allow stockholders to receive a return on their investment in the business through the receipt of company assets, often cash. This cash is paid out by the company to its stockholders on a date declared by the business's board of directors, but only if the company has sufficient retained earnings to make the dividend payments. Dividend payments are not recorded on income statements, and typically are only found in a retained earnings or stockholders' equity statement; both retained earnings and equity are decreased as a result of paying dividends.
Balance Sheet
Essentially, retained earnings are what allow a business's balance sheet to ultimately balance. They fit in neatly between the income statement and the balance sheet to tie them together. The income statement records revenue and expenses and allows for an initial retained earnings figure. The retained earnings statement factors in retained earnings carried over from the year before as well as dividend payments. On the balance sheet, the business's total assets, liabilities and stockholders' equity are visible and able to be reconciled as a result of recording retained earnings.
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