Retained earning statements

Periodically, perhaps on a monthly basis but certainly yearly, the ledger sheets are closed and balanced. The ledger sheets are used as intermediate documents between journal records and balance sheets, income statements, and retained earnings statements, as well as information for various government reports. For example, a consolidated income statement can be prepared from the ledger revenue and expense accounts. From the asset and liability accounts, a company s balance sheet is prepared. Table 3.2 is the ledger obtained from the general journal. Table 3.1. 

We have included parts of an annual report of a fictitious company, Archem, Inc., which we use to explain the terminology and construction of a balance sheet, an income statement, and a retained earnings statement. 

A financial report contains two important documents—the balance sheet and the income statement. Two other documents that appear in the financial report are the accumulated retained earnings and the changes in working capital. All these documents are discussed in the following sections using a fictitious company. 

It also shows the net income for year 1. It is important to understand that the terms net income and earnings are used interchangeably in financial reports. You will note that the net income for year 1 is 300,000. The balance sheet (Table 15-2) shows retained earnings of 200,000. This is the portion of the net income that the owners have reinvested in the business. Where did the rest ( 100,000) of the net income go It was redistributed among owners as dividends (as depicted in Table 15-4). The connection between the net income value from the income statement and retained earnings from the balance sheet is an example of how these two reports are linked. In this particular example, the details of this linkage can be examined by the statement of retained earnings (Table 15-4). 

Table 15-4. Whole Health Partners Statement of Retained Earnings for Year 1 ( )...

Table 10.4 follows the same general format as the example of personal income statement but applies to a hypothetical construction company. The hypothetical business for which the income statement was developed is for the same business in the calendar year for which Table 10.2, the balance sheet, was developed. One indication of the relationship between the balance sheet and the income statement is retained earnings of 252,755.21 in Table 10.2 and the identical retained earnings balance at the end of the year in Table 10.4. However, there are a few obvious connections between the construction company s balance sheet (Table 10.2) and its income statement (Table 10.4).

Finally, understanding how each financial statement is not only related to each other, but connected to each other is important. Looking back to Tables 2.1 to 2.3, or viewing the modified financial statements (Table 2.4), the connection between the financial statements through certain line items is clear. Notice that ending cash on the cash flow statement is equal to cash on the balance sheet. Net income on the income statement is equal to the net income on the statement of cash flows. Net income from the income statement is added to retained earnings on the balance sheet, and thus stockholders equity increases, though this transaction is not quite as apparent. 

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