Which Of The Following Is Likely To Be Found On A Statement Of Retained Earnings (Answered with Examples)
If you're studying accounting, preparing for an exam, or learning how financial statements work, you may encounter the following question:
Which of the following is likely to be found on a Statement of Retained Earnings?
Correct Answer: A) Net Income (or Net Loss) for the current accounting period.
However, that's only part of the answer. A Statement of Retained Earnings also includes the beginning retained earnings balance, dividends paid to shareholders, and the ending retained earnings balance. Together, these figures explain how a company's retained earnings changed during a specific accounting period.
Understanding this statement is important because it shows whether a business is reinvesting its profits to support future growth or distributing them to shareholders.
What Is a Statement of Retained Earnings?
A Statement of Retained Earnings is one of the core financial statements prepared by a business. It summarizes how retained earnings changed over a reporting period.
Retained earnings are the accumulated profits a company keeps after paying dividends to shareholders. Instead of distributing all profits, businesses often reinvest a portion of their earnings to finance expansion, purchase equipment, repay debt, or strengthen cash flow.
For investors, lenders, and business owners, this statement provides insight into how management is using company profits.
What Is Included in a Statement of Retained Earnings?
A standard Statement of Retained Earnings typically includes the following items:
1. Beginning Retained Earnings
This is the retained earnings balance carried forward from the previous accounting period. It serves as the starting point for the current statement.
2. Net Income or Net Loss
The company's profit or loss for the current accounting period is transferred from the income statement.
Net income increases retained earnings.
Net loss decreases retained earnings.
This is why Net Income (or Net Loss) is the correct answer in many accounting multiple-choice questions.
3. Dividends Paid
When a company distributes profits to shareholders, those dividend payments reduce retained earnings.
Dividends may be paid in cash or stock, depending on the company's dividend policy.
4. Ending Retained Earnings
After adding net income (or subtracting a net loss) and deducting dividends, the company arrives at its ending retained earnings balance.
This amount appears in the shareholders' equity section of the balance sheet.
Formula for Calculating Retained Earnings
The calculation is straightforward:
Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends
If the company reports a net loss, the formula becomes:
Ending Retained Earnings = Beginning Retained Earnings − Net Loss − Dividends
This simple calculation explains how profits earned during the year affect the company's accumulated earnings.
Example of a Statement of Retained Earnings
Suppose a company reports the following:
Beginning Retained Earnings: $120,000
Net Income: $45,000
Dividends Paid: $15,000
The calculation would be:
$120,000 + $45,000 − $15,000 = $150,000
The company would report Ending Retained Earnings of $150,000.
This example illustrates how profitable operations increase retained earnings while dividend distributions reduce them.
Why Retained Earnings Matter
Retained earnings are more than just an accounting figure. They help explain how a company finances its future.
Businesses commonly use retained earnings to:
Expand into new markets
Purchase machinery or equipment
Invest in research and product development
Repay loans and reduce financial risk
Increase working capital
Build cash reserves for future opportunities
Companies that consistently generate profits often accumulate higher retained earnings, giving them greater financial flexibility without relying heavily on external financing.
However, retained earnings should always be evaluated alongside other financial statements because a high balance alone does not guarantee strong financial performance.
What Happens If Retained Earnings Are Negative?
Negative retained earnings are known as an accumulated deficit.
This usually occurs when:
The company has experienced losses over multiple years.
Dividend payments exceeded cumulative profits.
A new business has not yet reached sustained profitability.
Negative retained earnings do not necessarily mean a business is failing. Many growing companies report accumulated deficits during their early years while investing heavily in expansion.
To assess financial health accurately, retained earnings should be considered together with revenue, cash flow, debt levels, and profitability.
Common Mistakes Students Make
Many learners confuse retained earnings with other financial terms. Here are a few common misconceptions:
Retained earnings are not cash. They represent accumulated profits, not the amount of money sitting in a bank account.
Retained earnings are not revenue. Revenue is income earned from business activities before expenses are deducted.
Retained earnings are not net income. Net income reflects profit for a single accounting period, while retained earnings represent the accumulated balance after accounting for prior years and dividends.
Understanding these differences can help you answer accounting exam questions correctly.
Frequently Asked Questions
Which item is most likely to appear on a Statement of Retained Earnings?
The statement includes:
Beginning retained earnings
Net income or net loss
Dividends paid
Ending retained earnings
If presented as a multiple-choice question, Net Income (or Net Loss) is often the correct answer because it is a key component of the statement.
Why are dividends deducted?
Dividends represent profits distributed to shareholders. Since those profits are no longer retained by the business, they reduce retained earnings.
Where do ending retained earnings appear?
The ending retained earnings balance is reported in the shareholders' equity section of the balance sheet and becomes the beginning balance for the next accounting period.
Key Takeaways
A Statement of Retained Earnings shows how retained earnings changed during an accounting period.
The statement includes beginning retained earnings, net income (or net loss), dividends, and ending retained earnings.
Net income increases retained earnings, while net losses and dividends reduce them.
Retained earnings help businesses finance growth without relying entirely on external funding.
Investors, lenders, business owners, and accounting students use this statement to understand how profits are managed over time.
Editorial Note: This article is intended for educational purposes and reflects generally accepted accounting principles (GAAP). Actual financial reporting requirements may vary depending on the accounting framework used (such as IFRS or local accounting standards). For financial reporting decisions, consult applicable accounting standards or a qualified accounting professional.
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