A complete set of financial statements includes not only the balance sheet and income statement, but also a statement of cash flows and a statement of retained earnings. The statement of retained earnings is sometimes called the statement of owners’ equity, or the statement of net assets for a not for profit organization. The statement can be included in either the balance sheet or on a combined income statement, but is often a separate statement. The first item on a statement of retained earnings is the beginning retained earnings balance for the period. Next is the net income or loss for the accounting period being reported, which is normally one year. After that, any cash dividends are subtracted, resulting in the ending retained earnings balance.
Sometimes, other items appear on the statement of retained earnings for a company. One example is a prior period adjustment. A prior period adjustment is needed when a business discovers that a material error has occurred in the computation of net income in one or more previous years. Net income gets closed into the retained earnings account each year, so an error in reported net income would result in the retained earnings amount on all subsequent balance sheets being incorrect. In the year the error is found and the correction is made, the prior period adjustment is reported on the statement of retained earnings as an adjustment to the beginning retained earnings balance, resulting in a restated beginning retained earnings balance.
Another item that sometimes appears on a statement of retained earnings is the restriction of retained earnings. When a portion of retained earnings is restricted, it is set aside for a specific purpose, and places a restriction against the company declaring a dividend that would reduce the retained earnings balance below a certain level. Normally, this information is disclosed as a note in the financial statements of the company rather than on the statement of retained earnings.
If there are any restrictions on retained earnings, they are listed and described on the balance sheet, with the unrestricted amount also identified. Sometimes retained earnings are restricted by the purchase of treasury stock. Treasury stock is defined as shares of a corporation’s capital stock that were issued and then later reacquired by the corporation. The shares might be issued again, or they could be held indefinitely by the corporation.
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