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What are Retained Earnings?

June 2, 2015

Tax Question:

What are Retained Earnings?

Facts:

Retained earnings are cumulative profits of the corporation that are not paid out as dividends to shareholders and are held or retained to be reinvested in the company for future growth.

Discussion:

Retained earnings (also referred to as Retained Surplus) summarize the cumulative earnings since the inception of the corporation less the dividends paid out to shareholders to date.

Closing Retained Earnings (RE) = Opening RE + Net Income – Dividends

Retained earnings are listed in the Shareholder Equity section of the Balance Sheet. They can also be listed on a separate financial statement called Statement of Retained Earnings. Changes in retained earnings can be reflected by an increase in assets (cash or equipment purchased) or a decrease in liabilities (debt paid down) as these represent utilization of the corporation’s wealth.

Many innovative companies use their retained earnings to fund further research and development to grow the corporation. A smaller corporation with fairly fast growth might have higher retained earnings than an older more established corporation which may be paying out more dividends to its shareholders. Retained earnings are not the same as cash because the calculation of profits includes non-cash items such as depreciation and cash may have been spent on items such as capital assets.

The opening balance of the retained earnings may be restated in some instances for retroactive changes to its financial statements due to a change in accounting principle or an error. The opening balance of the Retained Earnings should always agree to the prior year closing retained earnings balance. If the amounts don’t agree, then there is likely an error in the posting of adjusting entries from the prior year or a transaction has been posted or changed to a prior period after the books were closed. A corporation can have a negative retained earnings balance when a company pays out a large dividend that exceeds the available balance. It could also be possible for a corporation to have a negative balance if it has incurred losses historically. Investors and lenders may see this as a going concern issue and question the corporation’s ability to operate in the foreseeable future.

If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.

Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.

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