Retained earnings represent the cumulative net income of a company that has been retained (not distributed as dividends) and reinvested in the business. Below are examples of journal entries related to retained earnings, covering different scenarios.
Example 1: Closing Net Income to Retained Earnings
Scenario:
At the end of the fiscal year, a company has earned a net income of $50,000. This net income needs to be transferred to retained earnings.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Income Summary A/c Debit | 50,000 | |
| 12-31-2024 | To Retained Earnings A/c | 50,000 |
Explanation:
- Income Summary will debited to close the income account.
- Retained Earnings will credited to reflect the increase in retained earnings due to the net income.
Example 2: Declaring Dividends from Retained Earnings
Scenario:
The company declares dividends of $20,000 to be paid to shareholders. This amount will be deducted from retained earnings.
Journal Entry (When Dividends Are Declared):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 03-01-2025 | Retained Earnings A/c Debit | 20,000 | |
| 03-01-2025 | To Dividends Payable A/c | 20,000 |
Explanation:
- Retained Earnings will debited to reduce the amount available for reinvestment in the business.
- Dividends Payable will credited to recognize the liability to pay dividends.
Example 3: Paying Dividends
Scenario:
On April 1, 2025, the company pays the previously declared dividends of $20,000 to shareholders.
Journal Entry (When Dividends Are Paid):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 04-01-2025 | Dividends Payable A/c Debit | 20,000 | |
| 04-01-2025 | To Cash A/c | 20,000 |
Explanation:
- Dividends Payable will debited to eliminate the liability.
- Cash will credited to reflect the outflow of cash to shareholders.
Example 4: Adjusting Retained Earnings for a Prior Period Error
Scenario:
The company discovered an error in its previous year’s financial statements, where $5,000 in expenses were not recorded. This needs to be corrected by adjusting retained earnings.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-01-2025 | Retained Earnings A/c Debit | 5,000 | |
| 01-01-2025 | To Expenses A/c | 5,000 |
Explanation:
- Retained Earnings will debited to correct the cumulative effect of the error on prior earnings.
- Expenses will credited to reflect the reduction in previously understated expenses.
Example 5: Transferring a Portion of Retained Earnings to Reserves
Scenario:
The company decides to transfer $10,000 of its retained earnings to a reserve account to strengthen its financial position.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Retained Earnings A/c Debit | 10,000 | |
| 12-31-2024 | To Reserve Account A/c | 10,000 |
Explanation:
- Retained Earnings will debited to reduce the amount available for distribution or reinvestment.
- Reserve Account will credited to increase the company’s reserves.
These examples illustrate how retained earnings are managed in a company’s financial records, affecting dividends, reserves, and corrections to previous periods. Proper accounting of retained earnings ensures that the company accurately tracks its reinvested profits and financial health.