Hi, Else here.
And in this video, we'll be exploring
the statement of retained earnings under ASPE.
First, let's remind ourselves of the proper order
of the financial statements.
The income statement comes first.
The net income, or net loss, if expenses
are greater than revenues, is a measure
of a business's performance.
We covered the single step income statement
in our last video.
After the income statement, businesses following ASPE
must prepare a statement of retained earnings.
This statement reports how profits and dividends
have affected equity.
It is used because the majority of changes in equity
are due to the generation and distribution of earnings.
Information from this statement helps stakeholders assess
businesses use of profit.
How much is retained by the business for future growth
and how much is distributed to the shareholders?
In order to understand the statement of retained earnings,
we must first understand what makes up the element equity.
Equity is a difficult concept to grasp,
so we're going to keep it simple right now.
Equity is equal to wealth that is
due to the owners of the business
and it is made up of two items.
First, equity is the capital provided by the owners.
It represents the amount of cash,
goods, or services a business receives
from the owners in exchange for the business's shares.
For instance, if you start a business
with $20,000 of your own cash, then you
have $20,000 of capital in the business, which
would be recorded as equity.
Owner's capital is also called share capital
or contributed capital.
These terms are all interchangeable.
Second, equity is the earnings that the business generates
and keeps in the business.
For instance, if the business has
net income of $10,000 during the year,
then the equity would go up by $10,000.
If a portion of that net income was paid out to the owners
in the form of dividends, then equity
would go up by the amount of net income
less the amount of dividends.
Dividends are the profit which a business chooses to pay out
to the owners of the business.
For example, if a business had net income of $10,000,
but paid out dividends of $2,000 then equity
would increase by $8,000, which are the earnings
that the business has kept.
This is called retained earnings-- meaning the profit
or earnings kept or retained in the business.
So to summarize, equity is the capital invested by the owners,
plus the net income, less dividends
retained by the business.
Equity is owed to the owners of the business by the business.
Equity-- capital plus retained earnings owed to the owners.
The statement of retained earnings
focuses on how the retained earnings component of equity
is determined.
Let's take a look at the structure of this statement.
As always, the statement starts with the heading, which
must include the company name, the title
of the financial statement, and, similar to the income
statement, the time period covered.
The body of the statement always starts
with the beginning or opening balance of retained earnings.
This balance is always the closing or ending balance
from the prior year's statement of retained earnings.
In this case, the net income from all prior years,
less the dividends paid out in all prior years,
is equal to 92,400.
Next, the net income from the income statement
is added to the beginning balance.
If the company had a net loss, it
would reduce the prior year's retained earnings balance.
In this case, we have net income,
so we would add $17,100 to the opening balance of 92,400.
This results in a subtotal of 109,500.
Next, we deduct the dividends declared or paid to the owners.
Dividends are a distribution of wealth to the owners
by the business.
Remember that the wealth of the business
is owed to the owners and dividends,
therefore, reduce retained earnings and, by extension,
equity.
The total at the bottom of the statement is the ending
retained earnings-- the amount that
will be transferred to the equity section of the balance
sheet.
Pretty simple statement, but important to understand.
Let's just summarize what we learned.
The opening balance for the retained earnings
comes from the prior year's statement of retained earnings.
Net income comes from the bottom of the income statement.
Dividends are what has been either declared
or paid to the owners of the business-- also called
shareholders.
The ending balance is the amount that
will be carried to the equity section of the balance sheet.
This amount will become the opening balance
at the top of the statement of retained earnings next year.
Pause the video to answer the Check your understanding!
question.
What would be the business's ending retained earnings,
given the amounts provided?
A is incorrect.
You remember the opening balance, revenues,
and expenses, but you forgot to deduct the dividends.
C is incorrect, because it includes the contribution
by owners, which is part of equity,
but not part of retained earnings.
D is incorrect, because you deducted expenses,
but you added in the dividends when you
should have subtracted them.
B is the correct answer, because it includes
only the opening retained earnings, plus the revenue,
less the expenses, and less the dividends paid.
How do stakeholders use the statement of retained earnings?
Investors use information about retained earnings
to predict future dividend payments.
They also use it to see if the company is
retaining enough of their net income for future expansion.
Lenders use it to determine if dividend payouts are
appropriate and leave enough cash for debt repayment.
Other creditors use retained earnings information
to see if the earnings are being invested back
into the company's future.
As you already know, the statement of retained earnings
is connected to the equity section
of the balance sheet, which is the topic of our next video.