Friday, February 8, 2013

Statement of Retained Earnings How to Guide

Statement of Retained Earnings

Retained earnings generally consist of a company’s cumulative net income less any net losses and dividends declared since its inception. Retained earnings are part of stockholders’ claims on the company’s net assets, but this does not imply that a certain amount of cash or other assets is available to pay stockholders. For example, Research In Motion has $5,274,365 thousand in retained earnings, but only $1,550,861 thousand in cash. This section describes events and transactions affecting retained earnings and how retained earnings are reported.

Restrictions and Appropriations
The term restricted retained earnings Retained earnings not available for dividends because of legal or contractual limitations. refers to both statutory and contractual restrictions. A common statutory (or legal) restriction is to limit treasury stock purchases to the amount of retained earnings. The balance sheet in Exhibit 13.14 provides an example. A common contractual restriction involves loan agreements that restrict paying dividends beyond a specified amount or percent of retained earnings. Restrictions are usually described in the notes.

The term appropriated retained earnings Retained earnings separately reported to inform stockholders of funding needs. refers to a voluntary transfer of amounts from the Retained Earnings account to the Appropriated Retained Earnings account to inform users of special activities that require funds.

Prior Period Adjustments Prior period adjustments 
Correction of an error in a prior year that is reported in the statement of retained earnings (or statement of stockholders’ equity) net of any income tax effects. are corrections of material errors in prior period financial statements. These errors include arithmetic mistakes, unacceptable accounting, and missed facts. Prior period adjustments are reported in the statement of retained earnings (or the statement of stockholders’ equity), net of any income tax effects. Prior period adjustments result in changing the beginning balance of retained earnings for events occurring prior to the earliest period reported in the current set of financial statements. To illustrate, assume that ComUS makes an error in a 2009 journal entry for the purchase of land by incorrectly debiting an expense account. When this is discovered in 2011, the statement of retained earnings includes a prior period adjustment, as shown in Exhibit 13.15. This exhibit also shows the usual format of the statement of retained earnings.

EXHIBIT 13.15Statement of Retained Earnings with a Prior Period Adjustment

Point: If a year 2009 error is discovered in 2010, the company records the adjustment in 2010. But if the financial statements include 2009 and 2010 figures, the statements report the correct amounts for 2009, and a note describes the correction.

Many items reported in financial statements are based on estimates. Future events are certain to reveal that some of these estimates were inaccurate even when based on the best data available at the time. These inaccuracies are not considered errors and are not reported as prior period adjustments. Instead, they are identified as changes in accounting estimates Change in an accounting estimate that results from new information, subsequent developments, or improved judgment that impacts current and future periods. and are accounted for in current and future periods. To illustrate, we know that depreciation is based on estimated useful lives and salvage values. As time passes and new information becomes available, managers may need to change these estimates and the resulting depreciation expense for current and future periods.

Closing Process
The closing process was explained earlier in the book as:

(1) Close credit balances in revenue accounts to Income Summary,
(2) Close debit balances in expense accounts to Income Summary, and
(3) Close Income Summary to Retained Earnings. If dividends are recorded in a Dividends account, and not as an immediate reduction to Retained Earnings (as shown in this chapter), a
(4) is necessary to close the Dividends account to Retained Earnings.

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