¾ Retained earnings comprise the cumulative total since incorporation of net income
(less losses) less any declared dividends. The balance in retained earnings is part of
represent a claim on any specific asset. A debit balance in the retained earnings is
identified as a deficit.
Retained Earnings Restrictions
¾ These are a portion of the balance unavailable for dividends. Restrictions generally
are of one or more of the following types: Contractual restrictions (long-term debt)
and Voluntary restrictions (the board of directors may voluntarily create restrictions).
Retained earnings restrictions are generally disclosed in the notes to the financial
Prior Period Adjustments
¾ A prior period adjustment occurs when correcting an error related to a prior period,
and when changing an accounting principle. When a correction of an error or a
change in accounting principle results, the accounting principle treatment is similar:
the correct or new amount should be used in reporting the results, it should be
disclosed, all prior period financial statements should be corrected, and the effects
should be disclosed.
¾ Correction of Prior Period Errors ± the correction of a prior period error in previously
issued financial statements is made directly to retained earnings since the effect of the
error is now in this account. If the correction affects revenues and expenses, income
tax expense should also be corrected. Corporations pay income tax on revenue less
expenses, known as income before income tax.
¾ Change in Accounting Principle ± this is also known as a change in accounting
policy. This occurs when the principle used in the current year is different from the
one used in the preceding year. Examples of changes in accounting principles include
a change in calculating amortization.
Statement of Retained Earnings
¾ The statement of retained earnings shows the changes in retained earnings during the