3 2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions Principles of Accounting, Volume 1: Financial Accounting

3 2 Define and Describe the Expanded Accounting Equation and Its Relationship to Analyzing Transactions Principles of Accounting, Volume 1: Financial Accounting

It is important to have more detail
in this equity category to understand the effect on financial
statements from period to period. This
may be difficult to understand where these changes have occurred
without revenue recognized individually in this expanded
equation. Retained earnings appear on the balance sheet under the shareholders’ equity section. If a company pays stock dividends, the dividends reduce the company’s retained earnings and increase the common stock account.

• When a company issues a stock dividend, it distributes additional quantities of stock to existing shareholders according to the number of shares they already own.
• A high profit percentage eventually yields a large amount of retained earnings, subject to the two preceding points.
• Revenue is the income a company generates before any expenses are taken out.
• Retained earnings refer to the residual net income or profit after tax which is not distributed as dividends to the shareholders but is reinvested in the business.
• There is a hybrid owner’s investment labeled as preferred stock that is a combination of debt and equity (a concept covered in more advanced accounting courses).
• We begin with the left side of the equation, the assets,
  and work toward the right side of the equation to liabilities and
  equity.

Printing Plus has $100 of supplies expense, $75 of depreciation
expense–equipment, $5,100 of salaries expense, and $300 of utility
expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation
Expense–Equipment, Salaries Expense, and Utility Expense, and debit
Income Summary. The first entry
closes revenue accounts to the Income Summary account.

The Purpose of Retained Earnings

Retained earnings is a figure used to analyze a company’s longer-term finances. It can help determine if a company has enough money to pay its obligations and continue growing. Retained earnings can also indicate something about the maturity of a company—if Bookkeeping, tax, & CFO services for startups the company has been in operation long enough, it may not need to hold on to these earnings. In this case, dividends can be paid out to stockholders, or extra cash might be put to use. Buildings, machinery, and land are all considered long-term
assets.

• In summary, the accountant resets the
  temporary accounts to zero by transferring the balances to
  permanent accounts.
• If a business
  has net loss for the period, this decreases retained earnings for
  the period.
• That is the closing balance of the retained earnings account as in the previous accounting period.
• The primary elements that affect retained earnings are net income/ net loss and dividend payments.
• However, it is more difficult to interpret a company with high retained earnings.
• However, if the earlier report had understated expenses or overstated revenues, the necessary adjustments will reduce the net income, which will consequently result in a reduction in retained earnings.

A business entity can have a negative retained earnings balance if it has been incurring net losses or distributing more dividends than what is there in the retained earnings account over the years. Retained Earnings are reported on the balance sheet under the shareholder’s equity section at the end of each accounting period. To calculate RE, the beginning RE balance is added to the net income or reduced by a net loss and then dividend payouts are subtracted. A summary report called a statement of retained earnings is also maintained, outlining the changes in RE for a specific period. Retained earnings can typically be found on a company’s balance sheet in the shareholders’ equity section. Retained earnings are calculated through taking the beginning-period retained earnings, adding to the net income (or loss), and subtracting dividend payouts.

Financial and Managerial Accounting

You will learn about other assets as
you progress through the book. Let’s now take a look at the right
side of the accounting equation. The accounts are presented in the chart of
accounts in the order in which they appear on the financial
statements, beginning with the balance https://business-accounting.net/accounting-vs-law-whats-the-difference/ sheet accounts and then the
income statement accounts. Additional numbers starting with six and
continuing might be used in large merchandising and manufacturing
companies. The information in the chart of accounts is the
foundation of a well-organized accounting system.

The income statement
summarizes your income, as does income summary. If both summarize
your income in the same period, then they must be equal. Understanding the accounting cycle and preparing trial balances
is https://personal-accounting.org/crucial-accounting-tips-for-small-start-up/ a practice valued internationally. The Philippines Center for
Entrepreneurship and the government of the Philippines hold regular
seminars going over this cycle with small business owners.

Retained Earnings vs. Net Income

Any changes or movements with net income will directly impact the RE balance. Factors such as an increase or decrease in net income and incurrence of net loss will pave the way to either business profitability or deficit. The Retained Earnings account can be negative due to large, cumulative net losses. The RE balance may not always be a positive number, as it may reflect that the current period’s net loss is greater than that of the RE beginning balance.

• Even though the company does not have to pay the bill until
  June, the company owed money for the usage that occurred in May.
• Since company A made a net profit of $30,000, therefore, we will add $30,000 to $100,000.
• The company owing the product
  or service creates the liability to the customer.
• Revenue, sometimes referred to as gross sales, affects retained earnings since any increases in revenue through sales and investments boost profits or net income.