Retained earnings is one of the important aspects of a firm closing capital or equity. This earnings is usually an accumulation of profits earned yearly by the entity after paying dividends and reserves. And is added to the equity and reserves to arrive at shareholders’ fund.
Meaning of Retained Earnings
It is defined as accumulated profits that a business earned for several years after deducting losses and dividends.
It can also be referred to as profits accumulated overtime for growth and development of the entity.
Accumulated profit. This is the profits cumulated over several periods. As the company earns profits, it is credited to the retained earnings account every year.
For example, assuming in 2015 the company makes a profit of N1.2 million. Then, in 2016 a profit of N2.5 million, 2017 N1.8 million, 2018 N2.0 million, 2019 a loss of N0.8 million and a profit of N1.1 million in 2019. The addition of these profits is the retained earnings for 2019.
It is arrived at after deducting dividends. Generally, the owners or shareholders of a business have taken risks to invest their fund on the entity. Their reward is profits. Therefore, they have rights to all the profit earned for the year.
However, to keep some funds for growth, the directors will decide the portion of the profits it can give out as dividends to the shareholders. The dividends will be deducted to arrive at the earnings.
If the directors decide to set aside some of the profits as reserves. This will also be deducted from the profits or included as other comprehensive income. However, there are certain companies that must keep a portion of the profits for the year as reserves. This type of reserve is called statutory reserves. Banks keep this type of reserves.
It can be used for growth and development of the company. This fund is used in several ways. According to investopedia, retained earnings can be used as follows: To launch a new product or service, invested to expand the business to other locations, for mergers and acquisitions, shares buyback and paying outstanding loan obligations.
Formula for Retained Earnings
The formula for is:
RE = RE° + Profit for the year – (losses + dividends).
RE is retained earnings, RE° is retained earnings at the beginning of the period. And losses and dividends are deducted from it
MTN Nigeria Financial statement showing retained earnings for 2019.
The statement shows the accumulated earnings brought forward from 2018 to 2019. Profit for the year was added while dividends were deducted to arrive at the closing retained earnings for the year.
In conclusion, retained earnings are the entity’s owners or shareholders rewards that have been accumulated for several years. To be useful, it is declared as dividends and used for the development of the company.