What is retained earnings? Meaning, Formula & Balance Sheet Example
Retained earnings are a core concept in accounting, reflecting the portion of profit that a company keeps instead of distributing as dividends. Understanding retained earnings is vital for school and competitive exams, business studies, and anyone interested in financial management or analyzing company performance.
| Term | Definition | Example |
|---|---|---|
| Retained Earnings | Profits kept in the business after dividends | Earnings used to buy new equipment |
| Dividends | Profits distributed to shareholders | Annual payout to investors |
| Reserves | Funds set aside for specific purposes | General reserve, capital reserve |
What are Retained Earnings?
Retained earnings are accumulated profits not paid as dividends. These profits are reinvested in the business for growth, debt repayment, or other needs. The calculation is critical for exam questions and assessing a company's financial health. Students must know the retained earnings formula and its role in financial statements.
Retained Earnings Formula and Calculation
The calculation of retained earnings is simple but essential for accounting students. It involves adding the opening balance, net profit, and deducting dividends or any net losses. This formula is frequently asked in Commerce exams.
| Formula | Opening Retained Earnings + Net Profit - Dividends - Net Loss (if any) |
|---|---|
| Example | If a company starts the year with ₹10,000 retained earnings, earns ₹5,000 profit, and pays ₹2,000 as dividends, closing retained earnings = ₹10,000 + ₹5,000 – ₹2,000 = ₹13,000. |
Importance of Retained Earnings
Retained earnings are important because they show a company's ability to fund expansion, buy assets, or pay off liabilities without external borrowing. For students, understanding retained earnings helps solve exam MCQs and analyze company balance sheets effectively.
MCQs on Retained Earnings
Practice MCQs help reinforce the meaning, calculation, and balance sheet presentation of retained earnings. Here are some common exam-style questions with answers to test your understanding.
| # | MCQ | Options | Answer |
|---|---|---|---|
| 1 | Retained earnings are: |
(a) Always distributed as dividends (b) Accumulated profits not paid out (c) Similar to cash in hand (d) Always zero at year end |
(b) |
| 2 | Which formula correctly calculates closing retained earnings? |
(a) Opening retained earnings + Net Profit – Dividends (b) Total revenue – Total expenses (c) Share capital + Reserves (d) Net assets – Liabilities |
(a) |
| 3 | Where are retained earnings shown on a balance sheet? |
(a) Assets (b) Equity/Reserves and Surplus (c) Liabilities (d) Investments |
(b) |
| 4 | Retained earnings can decrease due to: |
(a) Net profit (b) Additional share capital (c) Payment of dividends (d) Increase in inventory |
(c) |
| 5 | Retained earnings are also known as: |
(a) Distributed profits (b) Paid-up capital (c) Accumulated profits (d) Loss reserves |
(c) |
Retained Earnings on the Balance Sheet
Retained earnings are most commonly reported in the “Reserves and Surplus” section on the equity side of the balance sheet. It reflects the total profits kept in the business since inception, after dividend payouts. See the illustration below for clarity.
| Balance Sheet Item | Example Amount (₹) |
|---|---|
| Share Capital | 1,00,000 |
| Reserves & Surplus (including Retained Earnings) |
15,000 |
| Total Equity | 1,15,000 |
Difference Between Retained Earnings and Reserves
Students often confuse retained earnings with reserves. Retained earnings are the total profits kept in the business, while reserves are specific appropriations from retained earnings for future use, such as general reserves or capital reserves. This difference is common in exam questions.
- Retained earnings: Not specifically earmarked; can be used as needed.
- Reserves: Set aside for defined purposes (e.g., contingency, development).
Practical Uses of Retained Earnings
A company may use retained earnings for business expansion, paying debts, or investment in new projects. In exams, scenarios often involve calculating the closing retained earnings or assessing its impact after a dividend is declared.
Example Scenario
If Company A has ₹20,000 as opening retained earnings, earns a net profit of ₹6,000, and pays dividends of ₹2,000, its closing retained earnings will be ₹24,000. This simple calculation helps in MCQ and written questions in exams.
Further Learning and Internal Links
Deepen your understanding by visiting Retained Earnings for comprehensive notes, or practice more multiple-choice questions using our DK Goel Solutions Class 12 Accountancy page. Understand the Profit and Loss Appropriation Account to see how profits and appropriations interact, or check the Final Accounts page for end-to-end financial statement clarity on this important concept.
At Vedantu, we simplify retained earnings concepts for easier exam preparation and deeper business understanding. This topic supports your school and competitive exams and builds a solid foundation for further studies in accountancy and commerce.
In summary, retained earnings are a key indicator of a company’s strength. They are important for exam MCQs and understanding financial statements. Practice calculations and MCQs regularly for best results and use Vedantu's resources for thorough revision.
FAQs on Retained Earnings MCQs: Questions, Answers & Concept Guide
1. What is retained earnings?
Retained earnings represent the accumulated profits of a company that have not been distributed as dividends to shareholders. These profits are reinvested back into the business for growth, expansion, or to cover future obligations. It's a crucial component of shareholders' equity on the balance sheet.
2. How to calculate retained earnings?
The retained earnings calculation involves a simple formula: Beginning retained earnings + Net profit – Dividends – Net losses = Ending retained earnings. For example, if a company starts with $10,000 in retained earnings, earns a net profit of $5,000, pays $2,000 in dividends, and incurs no losses, the ending retained earnings would be $13,000.
3. What is the second name of retained earnings?
Retained earnings are also known as accumulated profits or undistributed profits. These terms all refer to the same concept: the portion of a company's profits that are kept within the business rather than distributed to shareholders.
4. What is balance sheet MCQ?
A balance sheet MCQ (multiple-choice question) tests your understanding of the balance sheet, a financial statement that shows a company's assets, liabilities, and equity at a specific point in time. Questions might cover topics like calculating retained earnings, understanding the relationship between assets and liabilities, or identifying different types of accounts on the balance sheet. Retained earnings is a key component shown in the equity section.
5. Where are retained earnings shown in the balance sheet?
Retained earnings are reported under the shareholders' equity section on the balance sheet. This section shows the owners' stake in the company, including contributed capital and accumulated profits (retained earnings). It represents the cumulative profits the company has earned and retained over time.
6. What is retained earnings MCQ?
A retained earnings MCQ is a multiple-choice question that assesses your knowledge of this key accounting concept. These MCQs might cover the definition of retained earnings, how to calculate them, their impact on the balance sheet, or their relationship to dividends and profits. Understanding the formula and its application is essential.
7. Can retained earnings be negative, and what does that indicate?
Yes, retained earnings can be negative, which is often referred to as an accumulated deficit. This indicates that the company has experienced net losses over time that exceed its accumulated profits. It signifies a challenging financial situation for the business. The balance sheet will clearly show this negative figure.
8. How are retained earnings different from reserves?
While both retained earnings and reserves are part of shareholders' equity, they differ in their nature. Retained earnings represent the total accumulated profits not distributed as dividends. Reserves are specific portions of retained earnings set aside for particular purposes (e.g., contingency reserves, general reserves).
9. What accounting entries affect retained earnings at year-end?
At year-end, the closing entries that affect retained earnings include the transfer of net profit (or net loss) and the declaration and payment of dividends. These entries update the retained earnings balance to reflect the company's financial performance during the year.
10. Are retained earnings related to cash available in the business?
No, retained earnings do not directly represent the cash available in the business. They reflect the cumulative profits that have been earned and reinvested, regardless of whether those profits are currently held as cash or have been used for other purposes. Cash flow statements are better sources to show the current liquidity.
11. What is the formula for calculating retained earnings?
The basic formula for retained earnings is: Beginning retained earnings + Net income (profit) - Dividends - Losses = Ending retained earnings. This shows how the retained earnings balance changes over time due to profitability and dividend payouts.
