Q14RQ. - Horngren'S Financial And Managerial Accounting

Question

How does retained earnings increase? What are the two ways that retained earnings decreases?

Step-by-Step Solution

Answer

Retained earnings increase by revenues, and decreases by expenses and dividends of the business.

Step 1: Increase in retained earnings

Retained earnings are part of the equity. It represents the accumulated profits of the company. Revenues increase the businesses' earnings; hence it will increase retained earnings. 

Step 2: Decrease in retained earnings

Expenses are charges against revenues. It decreases the overall profits, which ultimately reduces the retained earnings. Dividends are paid to the shareholders from the retained earnings. Hence it will also decrease retained earnings.