Retained Earnings: Complete Guide (Definition, Formula, Examples)

by Eduyush Team

Retained Earnings: Complete Guide

Key Takeaways

Retained earnings = Beginning RE + Net Income − Dividends Paid
They appear under stockholders' equity on the balance sheet
A separate Statement of Retained Earnings shows the period-to-period movement
Retained earnings carry a normal credit balance
Negative retained earnings are called an "accumulated deficit"
Example: $250,000 beginning RE + $70,000 net income − $30,000 dividends = $290,000 ending RE

What are retained earnings?

Retained earnings are the portion of cumulative profits that a business has kept in the company instead of paying them out as dividends. Each year's profit or loss flows into retained earnings at the end of the period, and any dividends paid reduce that balance.

In simple terms, retained earnings tell you how much profit the company has reinvested over time. That is why they are sometimes called accumulated earnings or earned surplus.

If you are studying for the CPA FAR exam, retained earnings is one of the most frequently tested topics in the financial reporting section. Understanding this concept also helps when tackling financial statement analysis questions.

Retained earnings formula

The standard retained earnings formula is:

Ending Retained Earnings = Beginning Retained Earnings + Net Income − Dividends

This formula links three accounting period concepts:

Beginning retained earnings → the balance carried forward from the prior year
Net income (or net loss) → profit earned during the current period
Dividends → distributions to shareholders that reduce retained earnings

For a deeper look at how net income is determined and reported, see our guide on revenue recognition principles and the ASC 606 revenue recognition standard.

Why retained earnings matter

Retained earnings matter because they show whether a business is building internal capital over time. Management can use retained earnings to:

fund expansion and growth projects
buy new equipment or technology
reduce debt
build a working-capital buffer
support future dividend capacity

For analysts and students, retained earnings also help explain the relationship between the income statement, the statement of retained earnings, and the balance sheet. If you want to master how these statements connect, our 5 steps of revenue recognition guide explains how revenue ultimately flows into retained earnings.

Retained earnings are also central to cost-volume-profit analysis since profitability directly impacts the retained earnings balance over time.

Where retained earnings appear in the financial statements

1. Balance sheet

Retained earnings appear under shareholders' equity (or stockholders' equity) on the balance sheet.

Example extract:
Common stock ............... $100,000
Additional paid-in capital . $150,000
Retained earnings .......... $290,000
Total equity ............... $540,000

2. Statement of retained earnings

Many companies present a separate Statement of Retained Earnings showing how the balance moved from the start of the period to the end.

3. Statement of changes in equity

Under IFRS and in many larger companies, retained earnings are often shown inside the broader Statement of Changes in Equity. The BAR technical accounting section of the CPA exam tests your understanding of these equity disclosures.

Step-by-step example of retained earnings calculation

Suppose a company reports the following for 2025:

Beginning retained earnings = $250,000
Net income for the year = $70,000
Dividends declared and paid = $30,000

Apply the formula:

Ending retained earnings = $250,000 + $70,000 − $30,000 = $290,000

This means the company added a net $40,000 to its cumulative retained profits during the year.

Example with a net loss

Retained earnings can also decrease when a company incurs a loss.

Assume:

Beginning retained earnings = $120,000
Net loss = $25,000
Dividends = $10,000

Then:

Ending retained earnings = $120,000 − $25,000 − $10,000 = $85,000

Both the loss and the dividends reduce the retained earnings balance.

Understanding how variances in performance affect retained earnings is closely related to variance analysis, a key topic on the CPA BAR discipline.

Can retained earnings be negative?

Yes. When cumulative losses and/or dividend payments exceed cumulative profits, retained earnings become negative. This is called an accumulated deficit.

Negative retained earnings do not always mean a business is failing, but they usually signal that the company has experienced losses, aggressive distributions, or both.

Are retained earnings an asset or equity?

Retained earnings are part of equity, not an asset. They represent a claim on the company's net assets that belongs to owners after liabilities are paid.

This confusion happens because retained earnings often fund assets such as cash, equipment, or inventory — but the retained earnings account itself sits in the equity section. For more on equity components, read our stockholders' equity guide.

Are retained earnings a debit or credit?

Retained earnings normally carry a credit balance, because they arise from accumulated profits. Losses and dividends reduce the balance and are recorded as debits against retained earnings.

Journal entry connection

At period end, net income is closed into retained earnings. A simplified closing entry looks like:

Dr Income Summary ............ XX
Cr Retained Earnings ........ XX

If the company has a net loss, the direction reverses.

When dividends are declared and closed, retained earnings are reduced.

Mastering journal entries is essential for the FAR section of the CPA exam. If you are deciding which section to take first, check our guide on the best order to take CPA exams.

Common mistakes students make

Confusing retained earnings with cash
Thinking retained earnings are an asset
Forgetting that dividends reduce retained earnings
Ignoring prior-year balances when calculating ending retained earnings
Assuming negative retained earnings must mean immediate insolvency

Avoiding these mistakes is critical when preparing for the CPA exam. Our CPA exam strategy guide provides proven techniques to help you succeed on your first attempt.

Retained earnings vs revenue vs profit

Term	Meaning	Financial statement
Revenue	Sales generated during the period	Income statement
Net income	Profit after expenses and taxes	Income statement
Retained earnings	Cumulative profit kept in the business after dividends	Balance sheet / equity statement

Mini practice question

Question: A company has beginning retained earnings of $80,000, net income of $25,000, and dividends of $5,000. What is ending retained earnings?

Answer: $80,000 + $25,000 − $5,000 = $100,000.

Final takeaway

Retained earnings are cumulative profits that a company keeps for reinvestment instead of distributing as dividends. Once you know the formula — Beginning RE + Net Income − Dividends — you can quickly calculate the ending balance and understand how it flows through the financial statements.

If you are preparing for accounting or CPA exams, retained earnings are a foundational topic because they connect closing entries, equity reporting, and balance sheet presentation.