Statement of Retained Earnings Preparation
- Graziano Stefanelli
- Jul 3
- 2 min read
The statement of retained earnings is a key component of a company’s financial statements, showing the changes in retained earnings over a specific period. This statement links the income statement and balance sheet by explaining how net income and dividends affect equity.
Purpose and Importance
Retained earnings represent the cumulative net income of a company that has not been distributed to shareholders as dividends. The statement of retained earnings provides transparency about how profits are reinvested or returned to owners and helps users assess the sustainability of dividends, the financing of future expansion, or the capacity to absorb future losses.
Components of the Statement of Retained Earnings
The statement typically covers:
Beginning retained earnings: The balance carried forward from the previous period.
Net income or loss: As reported on the income statement for the current period.
Dividends declared: Both cash and stock dividends reduce retained earnings.
Corrections of prior period errors: Retrospective adjustments may impact the opening balance.
Changes in accounting principles: Also adjusted to the opening retained earnings, as required by standards.
Step-by-Step Preparation
Start with beginning retained earnings:Use the ending balance from the prior period or restated amount if adjustments are required.
Add net income (or subtract net loss):Bring in the current period’s profit or loss as reported on the income statement.
Subtract dividends declared:Deduct cash dividends, property dividends, and the fair value of any stock dividends.
Adjust for prior period errors or changes in principle:Add or subtract corrections made directly to retained earnings in accordance with ASC 250 or IAS 8.
Calculate ending retained earnings:The result is reported in the equity section of the current period’s balance sheet.
Illustrative Example
Suppose a company starts the year with $500,000 in retained earnings. It earns $120,000 net income, declares $30,000 in cash dividends, and corrects a $10,000 understatement of prior year’s expenses.
Beginning retained earnings: $500,000
Add: Net income: $120,000
Less: Dividends: $30,000
Less: Prior period adjustment: $10,000
Ending retained earnings:
$500,000 + $120,000 – $30,000 – $10,000 = $580,000
Sample Statement Format
Disclosure Requirements
Both US GAAP and IFRS require clear presentation of changes in retained earnings, including:
Restatements due to prior period errors or changes in accounting policy
The amount and nature of dividends
The effects of recapitalizations or share buybacks, if relevant
Some entities present the statement as a standalone report; others combine it with the statement of changes in equity.
Relevant Accounting Standards
US GAAP: ASC 505 – Equity; ASC 250 – Accounting Changes and Error Corrections
IFRS: IAS 1 – Presentation of Financial Statements; IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors
