Retained earnings are a crucial concept in accounting, representing the accumulated net earnings or profits of a company after accounting for dividend payments. This article aims to explore the relationship between retained earnings and the unadjusted trial balance, highlighting their distinct characteristics and the role of closing entries in the accounting cycle.
Key Facts
- Retained earnings represent the cumulative net earnings or profits of a company after accounting for dividend payments.
- The unadjusted trial balance is a list of all accounts and their balances before any adjustments are made at the end of an accounting period.
- Retained earnings are considered a permanent account, along with assets, liabilities, and most equity accounts.
- Permanent accounts, including retained earnings, carry forward their balances from one accounting period to the next.
- Temporary accounts, such as revenues, expenses, and dividends, are closed at the end of each accounting period and their balances are transferred to the retained earnings account.
- The closing process, which includes closing entries, is performed to zero out the temporary accounts and transfer their balances to the retained earnings account.
- The closing entries are the journal entry form of the Statement of Retained Earnings.
- The goal of the closing process is to make the posted balance of the retained earnings account match what is reported on the statement of retained earnings and start the next period with a zero balance for all temporary accounts.
Unadjusted Trial Balance
The unadjusted trial balance is a financial statement prepared at the end of an accounting period before any adjustments are made to the accounts. It lists all accounts and their balances, providing a snapshot of the company’s financial position before considering accrued revenues, expenses, and other adjustments. The unadjusted trial balance serves as the starting point for the adjusting process, which aims to ensure that the financial statements accurately reflect the company’s financial performance and position.
Retained Earnings: A Permanent Account
Retained earnings are considered a permanent account, along with assets, liabilities, and most equity accounts. Permanent accounts carry forward their balances from one accounting period to the next, accumulating over time. This characteristic distinguishes them from temporary accounts, such as revenues, expenses, and dividends, which are closed at the end of each accounting period.
Closing Entries and the Role of Retained Earnings
The closing process involves a series of journal entries made at the end of an accounting period to zero out the temporary accounts and transfer their balances to the retained earnings account. This process ensures that the retained earnings balance accurately reflects the company’s net income or loss for the period. The closing entries are the journal entry form of the Statement of Retained Earnings, which summarizes the changes in retained earnings during the period.
Impact of Closing Entries on the Unadjusted Trial Balance
The closing entries significantly impact the unadjusted trial balance. The balances of the temporary accounts, including revenues, expenses, and dividends, are reduced to zero, resulting in a post-closing trial balance that includes only the permanent accounts. This post-closing trial balance serves as the starting point for the next accounting period, with the retained earnings balance carried forward as the beginning balance.
Conclusion
Retained earnings are a permanent account that accumulates over time, representing the cumulative net earnings or profits of a company. The unadjusted trial balance, prepared before adjustments, provides a snapshot of the company’s financial position before considering accrued revenues, expenses, and other adjustments. The closing process, which includes closing entries, is performed to zero out the temporary accounts and transfer their balances to the retained earnings account. This process ensures that the retained earnings balance accurately reflects the company’s net income or loss for the period and aligns with the Statement of Retained Earnings.
References
- Edwards, J. D., & Hermanson, R. H. (2018). Accounting principles: A business perspective. Endeavour International Corporation.
- Fernando, J. (2023, March 23). Retained earnings in accounting and what they can tell you. Investopedia. https://www.investopedia.com/terms/r/retainedearnings.asp
- Lumen Learning. (n.d.). Journalizing and posting closing entries. Lumen Learning. https://courses.lumenlearning.com/suny-finaccounting/chapter/journalizing-and-posting-closing-entries/
- Lumen Learning. (n.d.). Preparing an adjusted trial balance. Lumen Learning. https://courses.lumenlearning.com/suny-finaccounting/chapter/preparing-an-adjusted-trial-balance/
FAQs
What is the unadjusted trial balance?
The unadjusted trial balance is a financial statement prepared before adjustments are made to the accounts at the end of an accounting period. It lists all accounts and their balances, providing a snapshot of the company’s financial position before considering accrued revenues, expenses, and other adjustments.
What are retained earnings?
Retained earnings are the cumulative net earnings or profits of a company after accounting for dividend payments. They are considered a permanent account and are carried forward from one accounting period to the next.
How are retained earnings related to the unadjusted trial balance?
Retained earnings are not included in the unadjusted trial balance because they are a permanent account and do not require adjustment at the end of the accounting period.
What is the purpose of closing entries?
Closing entries are journal entries made at the end of an accounting period to zero out the temporary accounts (revenues, expenses, and dividends) and transfer their balances to the retained earnings account.
How do closing entries impact the unadjusted trial balance?
Closing entries significantly impact the unadjusted trial balance. The balances of the temporary accounts are reduced to zero, resulting in a post-closing trial balance that includes only the permanent accounts.
What is the purpose of the post-closing trial balance?
The post-closing trial balance serves as the starting point for the next accounting period, with the retained earnings balance carried forward as the beginning balance.
Why are retained earnings important?
Retained earnings are important because they represent the company’s accumulated profits and are a source of funds for future investments, debt repayment, and dividend payments.
How can retained earnings be used?
Retained earnings can be used for various purposes, including expanding operations, paying off debt, investing in research and development, or issuing dividends to shareholders.