retained earnings

Examples of retained earnings in the following topics:

• The Cost of Retained Earnings

  • Due to the relationship between retained earnings and dividends, the cost of retained earnings as a source of capital is relative to the overall cost of equity.
  • Retained earnings indicate the amount of capital remaining after profits or losses from net income are paid out to investors and shareholders via dividends.
  • Retained earnings are reinvested back into the organization.
  • As a result, these retained earnings can essentially be viewed as a potential funding source for the organization.
  • Retained earnings is listed under equity, and is thus relative to the cost of equity.

• The Statement of Equity

  • A retained earnings statement is required by the U.S.
  • The retained earnings account on the balance sheet is said to represent an "accumulation of earnings" since net profits and losses are added / subtracted from the account from period to period.
  • Retained earnings are part of the statement of changes in equity.
  • The general equation can be expressed as following: ending retained earnings = beginning retained earnings − dividends paid + net income
  • The statement of retained earnings uses information from the income statement and provides information to the balance sheet.

• Dividend Payments and Earnings Retention

  • On the other hand, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends.
  • Retained earnings and losses are cumulative from year to year with losses offsetting earnings.
  • Many corporations retain a portion of their earnings and pay the remainder as a dividend.
  • Dividends paid are not classified as an expense but rather a deduction of retained earnings.
  • These retained earnings can be expressed in the retention ratio.

• Relationship Between Dividend Payments and the Growth Rate

  • The portion of the earnings not paid to investors is, ideally, left for investment in order to provide for future earnings growth.
  • Capital that is kept from investors is known as retained earnings.
  • Investors hope that firms will use retained earnings to either maximize their current operations or invest in such as a way as to lead to higher profits.
  • On the other hand, some companies can retain earnings and put that money back to work - i.e., invest in growth opportunities.
  • Firms that can do this tend to retain more of their earnings.

• Residual Dividend Model

  • The Residual Dividend Model first uses earnings to finance new projects, then distributes the remainder as dividends.
  • Companies which use retained earnings to finance new projects use this method.
  • What investors want are high returns - either in the form of dividends or in the form of re-investment of retained earnings by the firm .
  • The firm paying out dividends is obviously generating income for an investor; however, even if the firm diverts some earnings for investment opportunities, the income of the investors will rise later, assuming that those investments are profitable.
  • The dividend, therefore, fluctuates every year because of different investment opportunities and earning levels.

• Accounting Considerations

  • Retained earnings are part of the balance sheet (another basic financial statement) under "stockholders equity (shareholders' equity). " It is mostly affected by net income earned during a period of time by the company less any dividends paid to the company's owners/stockholders.
  • The retained earnings account on the balance sheet is said to represent an "accumulation of earnings" since net profits and losses are added/subtracted from the account from period to period.
  • The declaration of this dividend debits retained earnings for this value and credits the stock dividend distributable account for the number of new stock issued (150,000*.15 = 22,500) at par value.

• Expected Dividends, No Growth

  • Whether to issue dividends and what amount is calculated mainly on the basis of the company's unappropriated profit and its earning prospects for the coming year.
  • For example, shareholders of a "growth stock," expect that the company will, almost by definition, retain earnings so as to fund growth internally.
  • At the other end of the spectrum, investors of a "no growth," or value stock will expect the firm to retain little cash for investment, and to distribute a comparatively greater proportion to investors as a dividend.
  • As examples, such securities may be stock in public companies that have high dividend yields, low price-to-earning multiples, or have low price-to-book ratios.
  • Thus, high dividends and low reinvestment of retained earnings can signal an appealing value stock to an investor.

• Repurchasing Stock

  • Buying back shares can improve a company's price earnings ratio due to the reduced number of shares (and unchanged earnings).
  • It can improve EPS due to the fewer number of shares outstanding as well as unchanged earnings.
  • In either method, any transaction involving treasury stock cannot increase the amount of retained earnings.
  • If the treasury stock is sold for more than cost, then the paid-in capital treasury stock is the account that is increased, not retained earnings.
  • If the remaining 7,500 shares of stock are resold for less than the original $25 purchase price, and if the adjustment to treasury stock minus the proceeds from the sale is more than the balance of additional paid-in capital, an adjustment to retained earnings must be made.

• Value of a Low Dividend

  • A relatively low payout could mean that the company is retaining more earnings toward developing the firm instead of paying stockholders.
  • Furthermore, retained earnings lead to long-term capital gains, which have taxation advantages over high dividend payouts, according to the Taxation Preference Theory.
  • Dividend value must also be considered in relation to other measures of the firm, such as their earnings and stock price.
  • If the ratio is under 1, the company is using its retained earnings from a previous year to pay this year's dividend, which signals the risk of instability and poor performance of the firm.

• Chapter Questions

  • 2.Calculate the retained earnings of a corporation at the end of the year if retained earnings were $20,000 at the beginning of the year, net income was $50,000, declared $60,000 in dividends, and sold $50,000 in additional stock.
  • You deposit $5,000 into a bank that earns 10% APR.
  • You deposit $1,000 in a bank for two years.Which interest rate in APR must you earn for your ending balance to be $1,200?
  • You deposit your savings into a money market that earns 3% APR.
  • 13.If you are earning 16% APR on your investment that is compounded quarterly, compute the effective annual rate.