The Statement of Retained Earnings is the second financial statement that should be prepared in the accounting cycle after the income statement. Retained earnings are the portion of net income not paid out to investors in the business as dividends. Retained earnings are reinvested in the business firm.
The Statement of Retained Earnings explains the change in the retained earnings account and in dividends over a period of time. Retained earnings are the amount of income left in the company after dividends are paid. This income is reinvested in the firm for various projects. Here is an example of a statement.
1. Prepare the Heading for the Statement of Retained Earnings
A Statement of Retained Earnings should have a three-line header. The first line is the name of the company. The second line is simply, "Statement of Retained Earnings." The third line is "For the Year Ended XXXXX." For the word "year," any accounting time period can be entered.
2. State the Balance of Retained Earnings from the Prior Year
The first item on the Statement of Retained Earnings should be the balance of retained earnings from the prior year. This comes from the prior year's balance sheet. Let's say that the balance of retained earnings for our hypothetical firm is $20,000. The first line for the Statement of Retained Earnings would look like this:
3. Add Net Income from the Income Statement
The Statement of Retained Earnings should be the second financial statement prepared. The Income Statement is the first financial statement prepared. Let's say that net income from the hypothetical company is $10,000. That is the first item added into the Statement of Retained Earnings. Our retained earnings statement is now going to look like this:
If the company has a net loss on the Income Statement, then the net loss is subtracted from the existing retained earnings.
4. Subtract Dividends that your Company Pays out to Investors
Does your company pay dividends? If it does, you subtract the amount of dividends your company pays out of net income. If it does not, then you subtract $0. Let's say your company's dividend policy is to pay 50 percent of its net income out to its investors. In this example, $5000 would be paid out as dividends and subtracted from the current total.
5. Prepare the Final Total for Retained Earnings for 2009
Subtract out the dividends, if you pay dividends, and total the Statement of Retained Earnings. This is the amount of retained earnings that you post to the retained earnings account on your new 2009 balance sheet.
This completes the Statement of Retained Earnings.