The information in this article applies to:
The Retained Earnings Account is simply an account that shows the net of a firm's earnings or losses. It is up to the firm to decide how to distribute the balance of this account. It can be distributed periodically to the owners of the firm, retained for reinvestment, transferred to the partner's capital accounts, or transferred to prior year's Retained Earnings. This article discusses how the Retained Earnings Account is used in the Tabs3 General Ledger Software. A Frequently Asked Questions section is included that addresses many commonly asked questions regarding the Retained Earnings Account.
In manual accounting, the Retained Earnings Account is often defined as an "Income Summary" account. In a manual system, journal entries are typically made at the first of each month in order to bring Income and Expense account balances to zero so firms can get a true picture of the income and expenses each month. The Tabs3 General Ledger Software makes this process easier by automating it. Every time a journal entry is posted to an income or expense account, the balance of the retained earnings account is adjusted as well. Then, at the beginning of each month, the income and expense account balances will start out at zero so in effect, these balances have already been "transferred" to the Retained Earnings account.
In GLS, accounts are assigned an Account Type, which consist of Asset accounts, Liability accounts, Income accounts, Expense accounts or a Retained Earnings account. There can only be one account with an Account Type of Retained Earnings and it is a required account. All other equity accounts are classified as Liability accounts. Normally, the retained earnings account has a credit Balance Type.
The Balance Sheet in GLS retrieves the specified balances from the chart of accounts for all asset and liability accounts. However, the Balance Sheet in GLS calculates the Retained Earnings account balance as opposed to retrieving it from the chart of accounts. The formula used to calculate the balance for the Retained Earnings account on a Balance Sheet is the following:
Assets minus Liabilities = Retained Earnings
Note: Keep in mind that in GLS, other equity/capital accounts are classified as Liability accounts.
The balance of the retained earnings account is automatically updated whenever a journal entry is posted to an income or expense account. It is also updated when a manual journal entry is made directly to the account. When verifying account balances, it is important to verify that the Retained Earnings Account on the Balance Sheet matches the balance shown on the Balances tab in the Chart of Accounts program. This comparison is performed for each of the 36 months' balances that are maintained in GLS when the Data File Integrity Check is run. If the calculated balance does not match the balance shown in the chart of accounts, an error 76 is reported.
Let's assume we are starting with a new set of books. All account balances start at zero. On November 2, the firm receives a payment for services rendered in the amount of $100. The journal entries would be as follows:
Account |
Debit/Credit |
Amount |
New Account Balance |
Cash |
Debit |
$100 |
$100 |
Income |
Credit |
$100 |
$100 |
|
Retained Earnings (auto posting) |
Credit |
$100 |
$100 |
In November, the firm pays an expense of $20. The journal entries would be as follows:
Account |
Debit/Credit |
Amount |
New Account Balance |
Cash |
Credit |
$20 |
$80 |
Expense |
Debit |
$20 |
$20 |
|
Retained Earnings (auto posting) |
Debit |
$20 |
$80 |
No other activity occurs. The month of November is closed out. The following shows the ending November balances and the beginning December balances:
Account |
Ending Nov. Balance |
Beginning Dec. Balance |
Cash |
$80 |
$80 |
Retained Earnings |
$80 |
$80 |
Income |
$100 |
$0 |
Expense |
$20 |
$0 |
The Balance Sheet calculates the amount for the Retained Earnings account as $80 also using the formula Assets - Liabilities ($80 minus $0 = $80). The Income and Expense amounts for the month of December start at 0, thus the balances were effectively transferred to the Retained Earnings account. Additionally, the Retained Earnings account is equivalent to the YTD Net Profit and Loss on the Income Statement for the current fiscal year (i.e., $100 income minus $20 expenses = $80 Net Profit). This assumes that nothing has been transferred out of the Retained Earnings account, such as distributions.
At the end of the year, journal entries need to be made to the Retained Earnings account to bring the account to a zero balance in order for the Retained Earnings account to equal the Net Profit/Loss on the Income Statement for subsequent years of business. Verify with your accountant what entries need to be made. In the above example, the following journal entries could be made to clear the Retained Earnings account for your firm. This method is commonly used if you do not have the year-end adjusting entries from your accountant. The Prior Year's Retained Earnings is a liability account and has the same Balance Type as the Retained Earnings account--typically a credit Balance Type.
Account |
Debit/Credit |
Amount |
New Account Balance |
Retained Earnings |
Debit |
$80 |
$0 |
Prior Year's Retained Earnings |
Credit |
$80 |
$80 |
Once you are ready to distribute the Retained Earnings, you simply debit the Prior Year's Retained Earnings account and credit the appropriate partner's equity/stockholder accounts (i.e., assuming a profit). Or, if retained earnings was previously transferred to a "Prior Year's Retained Earnings account, debit Prior Year's Retained Earnings and credit the appropriate partner's equity/stockholder accounts.
Q1) It appears that a one-sided journal entry is being posted to the Retained
Earnings account every time a journal entry is posted to an income or expense account.
Why do you allow one-sided entries?
The Retained Earnings account is adjusted every time a journal entry is
posted to an income or expense account; however, a physical journal entry is not
actually posted. The Retained Earnings account is simply a "results" account. Since
the income and expense account balances start out at zero at the beginning of
each month, the results are being transferred to the Retained Earnings account
automatically.
Q2) The Retained Earnings balance on the Balance Sheet does not match the YTD Net Profit/Loss
on my Income Statement. How do I correct this?
The following calculations are performed to calculate Retained Earnings on the
Balance Sheet and the Net
Profit/Loss on the Income Statement:
Figure |
Formula |
Retained Earnings Balance on Balance Sheet |
Assets - Liabilities |
YTD Net Profit/Loss Amount on Income Statement |
Income - Expenses |
If these two figures do not match, either the Retained Earnings balance from prior years was not zeroed out properly at the end of the year; or, one or more of the components in the calculation are not correct. This could be due to a number of reasons. The steps listed below will help you troubleshoot this issue.
Q3) I ran a Trial Balance and Income Statement for the month of November.
The amount posted to "Gain/Loss Posted to xxx.xx Retained Earnings"
listed at the bottom of the Trial Balance does not match the MTD Net Profit/Loss
balance on my Income Statement. How do I correct this?
The following calculations are performed to calculate the "Gain/Loss Posted
to Retained Earnings" on the Trial Balance and Net
Profit/Loss on the Income Statement:
Figure |
Formula |
"Gain/Loss Posted to xxx.xx Retained Earnings" at bottom of Trial Balance |
Ending Month Balance minus |
MTD Net Profit/Loss Amount on Income Statement |
Income - Expenses |
If these two balances do not match, one or more of the components in the calculation are not correct. This could be due to a number of reasons. The steps listed below will help you troubleshoot this issue.
Q4) What journal entries should we make at the end of the
year?
No extra journal entries are required prior to performing a year-end closeout. Because of the way the software works, you do not have to close out
the income and expense accounts to the Profit/Loss account, nor do you have to
close out the Profit/Loss account (income summary) like you would when using a
manual accounting system. However, at the end of the year, you may want to close
out the Retained Earnings account so that it starts with a zero balance for the
new year. This is accomplished by making manual journal entries. For example, if
you have a liability account called Previous Year's Retained Earnings and the
Retained Earnings account is set up as your Current Year's Retained Earnings
account, you would debit Current Year's Retained Earnings and credit Previous
Year's Retained Earnings (assuming there is a profit for the year). (Note: The
year-end adjusting entries will vary depending on many circumstances [e.g., if
the firm is a sole proprietorship, a partnership or a corporation, how the chart
of accounts is set up, tax considerations, etc.]. Consult your accountant for
the proper adjusting year-end journal entries for your firm.)
Q5) At the end of each year, I make adjusting journal
entries to bring the Type "R" (Retained Earnings) account to a zero
balance. What date should these entries be assigned--the last day of the year I
am closing out or the first day of the new year?
Dating them the last day of your prior fiscal year will bring the Type
"R" account to a zero balance at the end of the closing year. Dating
the entries with the first day of the new fiscal year allows you to compare last
year's Retained Earnings balance to the current year's Retained Earnings balance
on the Balance Sheet. You may want to consult your accountant.
Q6) After printing the Balance Sheet and Trial Balance, I
noticed that the Retained Earnings figure is different. How is the Retained
Earnings figure calculated for these two reports, and what would cause them to
be different?
In order to calculate the Retained Earnings figure (Account Type
"R"), the software subtracts all of the Liability accounts (Account
Type "L") from the Asset accounts (Account Type "A"). Any
Owner Equity accounts will be included with the other Liability accounts
because they are set up with an Account Type of "L".
The Trial Balance retrieves the Ending Balance for the Retained Earnings account directly from the Chart of Accounts. The Retained Earnings figures for the Trial Balance and Balance Sheet should be the same.
If a one-sided journal entry, or an unbalanced journal entry was made (for example, a $50 debit and a $60 credit), then the Retained Earnings figure on the Trial Balance and Balance Sheet will not match. Discrepancies in the Retained Earnings account can also be caused when incorrect initial balances are entered or when a Balance Sheet account balance is edited incorrectly.
Q7) We still have not received our year-end adjustments from our accountant.
Currently our Retained Earnings Account has a beginning balance for January 2009
that will be removed when we make our closing entries for 2008. We normally
compare our Retained Earnings Account balance with the Year-to-Date Profit/Loss
figure on our Income Statement. Is there a different number we can compare until
we make our closing entries to verify that our reports balance?
One way you can compare is to subtract the January 2009 beginning balance for
the Retained Earnings Account from the ending balance in the Retained Earnings
Account for the months you are comparing. Compare this figure with the
Year-to-Date Profit/Loss figure on your Income Statement. Another option would
be to compare the Gain/Loss posted to Retained Earnings on the bottom of your
Trial Balance or General Ledger Report to the Month-to Date Profit/Loss figure
on your Income Statement.
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