A liability item that consists of the cumulative total of net earnings and losses, less any dividends declared and distributed, related to all prior periods. The amount of retained earnings that an entity may pay as cash dividends may be less than total retained earnings for many reasons, including contractual obligations, regulatory restrictions, or voluntary reasons. In equation form, retained earnings are calculated as follows:
RE = RE0+ NI – NL – Div
Where: RE, RE0, NI, NL, and Div denote retained earnings, retained earnings at the beginning of the period, net income, net loss, and dividends, respectively. In case an entity reports “positive” net income, NL will be zero, and if net losses are reported, then NI will be zero.
Retained earnings may be used as a source of finance for investment opportunities or proposals for growth purposes: an entity may opt for internal sources such as retained earnings rather than depending on other sources, whether internal (issue of equity) or external (issue of debt). Other reasons for retaining earnings include paying down debt or acquisition of new assets.
In essence, retained earnings are those amounts put aside, from net income, at the end of a reporting period. Depending on the way an entity treats retained earnings, these internal source of funds may come in multiple forms: appropriated and unappropriated retained earnings, and restricted and unrestricted retained earnings.
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