![]() ![]() Many states restrict retained earnings by the cost of treasury stock, which prevents the legal capital of the stock from dropping below zero. Some of the restrictions reflect the laws of the state in which a company operates. Restricted retained earnings is the portion of a company’s earnings that has been designated for a particular purpose due to legal or contractual obligations. Retained earnings is often subject to certain restrictions. When the retained earnings balance drops below zero, this negative or debit balance is referred to as a deficit in retained earnings. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) A statement of retained earnings for Clay Corporation for its second year of operations ( Figure 14.12) shows the company generated more net income than the amount of dividends it declared.įigure 14.12 Statement of Retained Earnings for Clay Corporation. A company preparing a full set of financial statements may choose between preparing a statement of retained earnings, if the activity in its stock accounts is negligible, or a statement of stockholders’ equity, for corporations with activity in their stock accounts. A basic statement of retained earnings is referred to as an analysis of retained earnings because it shows the changes in the retained earnings account during the period. It generally consists of the cumulative net income minus any cumulative losses less dividends declared. ![]() Retained earnings is the primary component of a company’s earned capital. 14 Characteristics and Functions of the Retained Earnings Account The stockholders’ equity section of Cracker Barrel Old Country Store, Inc.’s consolidated balance sheet as of July 28, 2017, and July 29, 2016, shows the company’s contributed capital and the earned capital accounts. On the balance sheet, retained earnings is a key component of the earned capital section, while the stock accounts such as common stock, preferred stock, and additional paid-in capital are the primary components of the contributed capital section. The second category is earned capital, consisting of amounts earned by the corporation as part of business operations. ![]() The first is paid-in capital, or contributed capital-consisting of amounts paid in by owners. The stockholders’ equity section of the balance sheet for corporations contains two primary categories of accounts. ![]() Unlike these other entity forms, owners of a corporation usually change continuously. Corporations differ from sole proprietorships and partnerships in that their operations are more complex, often due to size. Partnerships utilize a separate capital account for each partner, with each capital account holding the respective partner’s investments and the partner’s respective share of net income, with reductions for the distributions to the respective partners. Sole proprietorships utilize a single account in owners’ equity in which the owner’s investments and net income of the company are accumulated and distributions to the owner are withdrawn. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) Three Forms of Business Ownershipīusinesses operate in one of three forms-sole proprietorships, partnerships, or corporations. The relationship among assets, liabilities, and equity is represented in the accounting equation. Partnerships (to be covered more thoroughly in Partnership Accounting) often label this section of their balance sheet as “partners’ equity.” All three forms of business utilize different accounting for the respective equity transactions and use different equity accounts, but they all rely on the same relationship represented by the basic accounting equation ( Figure 14.11).įigure 14.11 Accounting Equation. While “owners’ equity” is used for all three types of business organizations (corporations, partnerships, and sole proprietorships), only sole proprietorships name the balance sheet account “owner’s equity” as the entire equity of the company belongs to the sole owner. From a practical perspective, it represents everything a company owns (the company’s assets) minus all the company owes (its liabilities). It is often referred to as net worth or net assets in the financial world and as stockholders’ equity or shareholders’ equity when discussing businesses operations of corporations. Owners’ equity represents the business owners’ share of the company. ![]()
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