Statement of Retained Earnings

Changes in retained earnings between balance sheet dates are reported in the statement of retained earnings. Table 9-3 shows that MicroDrive began the year with $710 million of retained earnings, earned $113.5 million during 2002, paid out $57.5 million in common dividends, and plowed $56 million back into the business. Thus, the balance sheet item "Retained earnings" increased from $710 million at the end of 2001 to $766 million at the end of 2002.

TABLE 9-3 MicroDrive Inc.: Statement of Retained Earnings for Year Ending December 31, 2002 (Millions of Dollars)

See Ch 09 Tool Kit.xls for details.

Balance of retained earnings, December 31, 2001 Add: Net income, 2002 Less: Dividends to common stockholders Balance of retained earnings, December 31, 2002

aHere, and throughout the book, parentheses are used to denote negative numbers.

Note that "Retained earnings" represents a claim against assets, not assets per se. Moreover, firms retain earnings primarily to expand the business, and this means investing in plant and equipment, in inventories, and so on, not piling up cash in a bank account. Changes in retained earnings occur because common stockholders allow the firm to reinvest funds that otherwise could be distributed as dividends. Thus, retained earnings as reported on the balance sheet do not represent cash and are not "available" for the payment of dividends or anything else.4

What is the statement of retained earnings, and what information does it provide? Why do changes in retained earnings occur?

Explain why the following statement is true: "Retained earnings as reported on the balance sheet do not represent cash and are not 'available' for the payment of dividends or anything else."

Self-Test Questions

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