Retained Earnings quiz #1 Flashcards
Retained Earnings quiz #1
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What are retained earnings in accounting?
Retained earnings are the net income from previous periods that has not been distributed to shareholders as dividends. Are retained earnings the same as cash on hand? Why or why not?
No, retained earnings are not the same as cash on hand because they may have been invested in assets or used for other purposes, not necessarily kept as cash. What is the base formula for calculating the ending balance of retained earnings?
Beginning balance + net income (additions) - dividends and net losses (subtractions) = ending balance. How does net income affect retained earnings?
Net income increases retained earnings. How do dividends affect retained earnings?
Dividends decrease retained earnings. What happens to retained earnings if a company experiences a net loss?
A net loss decreases retained earnings. Can a company have positive retained earnings but not enough cash to pay dividends? Explain.
Yes, because retained earnings may be invested in assets and not available as cash. What is a retained deficit?
A retained deficit occurs when a company has accumulated net losses or has paid out more dividends than its total net income, resulting in a negative retained earnings balance. How is a retained deficit shown in the retained earnings account?
A retained deficit is shown as a debit balance in the retained earnings account. Why might a startup company have a retained deficit?
A startup might have a retained deficit because it is investing heavily and may not have generated enough revenue yet to cover its expenses. What does a retained deficit indicate about a company’s financial health?
A retained deficit can indicate financial trouble, but it may be temporary for startups. In the T-account for retained earnings, what side are net income and dividends recorded on?
Net income is recorded on the credit side (increases), and dividends are recorded on the debit side (decreases). What is the effect of declaring dividends on the retained earnings account?
Declaring dividends reduces the retained earnings account. Can retained earnings be used to purchase assets? Explain.
Yes, retained earnings can be used to purchase assets such as machinery or inventory. If a company has a beginning retained earnings balance of $10,000, net income of $5,000, and dividends of $2,000, what is the ending retained earnings balance?
$10,000 + $5,000 - $2,000 = $13,000 ending retained earnings. What are the two main ways retained earnings can decrease?
Retained earnings decrease through net losses and the payment of dividends. Is it possible for a company to have a negative retained earnings balance? If so, what is it called?
Yes, it is called a retained deficit. Why is it important to distinguish between retained earnings and cash?
Because retained earnings may be invested in non-cash assets, so the amount does not represent available cash. What does the base formula help accountants track in the retained earnings account?
It helps track the changes in retained earnings due to net income, dividends, and net losses. How does the retained earnings account relate to the equity section of the balance sheet?
Retained earnings are part of the equity section, representing accumulated profits not distributed as dividends. What is the impact on retained earnings if a company pays more in dividends than its net income for the year?
Retained earnings will decrease, and if the excess is large enough, it could result in a retained deficit. How are multiple additions and subtractions handled in the retained earnings base formula?
All additions (net incomes) are summed, and all subtractions (dividends and net losses) are subtracted to find the ending balance. What is the typical balance (debit or credit) for retained earnings?
Retained earnings typically have a credit balance. What does it mean if the retained earnings account has a debit balance?
It means the company has a retained deficit, indicating accumulated losses or over-distribution of dividends. Can the base formula for retained earnings be applied to other accounts? Give an example.
Yes, it can be applied to accounts like inventory or accounts receivable. What is the primary purpose of retained earnings for a company?
To reinvest profits back into the business rather than distribute them as dividends. How does the declaration of dividends differ from the payment of dividends in terms of retained earnings?
Retained earnings decrease when dividends are declared, not when they are paid. If a company has a net loss for the year, what is the effect on retained earnings?
A net loss decreases retained earnings. Why might a company with positive retained earnings still be unable to pay dividends?
Because the retained earnings may be tied up in non-cash assets, leaving insufficient cash for dividend payments. What is the relationship between retained earnings and shareholder equity?
Retained earnings are a component of shareholder equity, representing accumulated profits not paid out as dividends. How is the ending balance of retained earnings reported on the financial statements?
It is reported in the equity section of the balance sheet. What are the possible reasons for a company to have a retained deficit?
Accumulated net losses or paying out more dividends than total net income. How does the retained earnings account reflect a company’s profitability over time?
It accumulates net income over time, less any dividends or net losses, showing long-term profitability. What is the effect on retained earnings if a company issues new shares of stock?
Issuing new shares does not affect retained earnings; it affects common stock and additional paid-in capital. If a company has a beginning retained earnings of $20,000, a net loss of $3,000, and pays $2,000 in dividends, what is the ending retained earnings?
$20,000 - $3,000 - $2,000 = $15,000 ending retained earnings. Why is it important for investors to review a company’s retained earnings?
It shows how much profit has been reinvested in the business and can indicate financial stability or trouble. What is the impact on retained earnings if a company has no net income and no dividends for the year?
Retained earnings remain unchanged. How can retained earnings be negative even if a company is currently profitable?
If past losses or dividend payments exceeded past profits, retained earnings can be negative despite current profitability. What is the significance of the retained earnings account for a company’s growth?
It provides funds for reinvestment in the company, supporting growth and expansion. How does the retained earnings account interact with the statement of retained earnings?
The statement of retained earnings shows the changes in the retained earnings account over a period.
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