 Hello and welcome to this session. This is Professor Farhad and this session we would look at the statement of retained earning and stockholders equity statement. This topic is covered in introductory accounting course, intermediate accounting and the statement of retained earnings and retained earning concept is covered in advanced accounting. So this is a very important concept for you to understand and I'm going to be approached it from a basic perspective. As always I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus actually right now 1700 plus accounting, auditing, finance and tax lectures. This is a list of all my courses. If you like my lectures, please like them, share them, put them in playlist, subscribe, connect with me. If they help you, it means they might help other people so share the wealth. Follow me on Instagram and on my website you will have additional resources such as PowerPoint slides through false multiple choice practice exercises. If you're a CPA candidate, I do have plenty of resources, thousands of CPA questions, exercises, CPA quasi CPA simulation that's going to help you get those extra 10 to 15 points. So check out my website. So let's talk about the statement of retained earning. What would the statement of retained earning looks like? This is what the statement of retained earnings looks like. We will start with the beginning retained earnings and let's assume it's a new company. If this is a new company, we have no retained earning at the beginning of year zero. So when we start, we have no retained earnings and what's going to happen? The company will generate revenues. Let's assume $100,000 of revenues and they will incur expenses to operate the business. Let's assume $60,000 of expenses and they will have a net income of $40,000 for that particular year. So what's going to happen? We started with zero retained earnings because we had no earnings. Then we add net income because we generated net income of $40,000. Then what's going to happen with this $40,000? The company might pay out some of it. So let's assume for the sake of simplicity, this company has a payout ratio of 25%. So they're going to pay 25%, which is $10,000 in dividend and what's not paid in dividend, which is $30,000, the company keeps. So we're going to pay $10,000 in dividend and that's going to be minus $10,000 and the company will keep $30,000. Now this is the ending retained earnings. Now this is year one. Now when we start year two, here's what's going to happen in year two. When we start year two, the beginning retained earnings becomes $30,000. Now remember the ending was $30,000 and year two, the beginning becomes $30,000. Then we add net income or if we incur net loss, we subtract net loss, we subtract dividend, then we have ending retained earnings and ending retained earnings becomes beginning retained earnings. And this is basically what it looks like. For example, this company here, company ABC, they have retained earnings as of December 31st, 2017 of $50,000. This is the beginning of 2018. So notice December 31st, 2019, it's technically January 1st, 2018. Then they incurred net income. They generated net income of $20,000. Then they paid dividend. They paid dividend more than what they generated in net income for that particular year. But they had enough from prior years. Then the ending retained earnings is $30,000. Now when we start, when we prepare our December 31st, 2018 retained earnings, the beginning retained earnings becomes $30,000. Then we add the new net income, subtract the new dividend, then we have the new retained earnings. So this is basically how retained earnings work. So it's very important to understand that retained earnings is a cumulative amount. And if you remember from closing the accounting record, retained earnings is that account that everything is close to all the net income losses dividend is close to. So it's a cumulative over the years of reported net income, minus losses, minus dividend declared since the company started its operation. So every time you think of retained earnings, here's what you should be thinking about mainly. If this is the account retained earnings, this is what it should look like. Net income on the credit, loss on the debit, and dividend on the debit. So those reduces retained earnings and net income increases retained earnings. Are these the only thing that affects retained earnings? No, there are other things that affects retained earnings, but those are the main three activities that affect retained earnings. We have treasury stock losses. If you had a few sold treasury stock at a loss, which we saw in the prior session, it would reduce retained earnings. If there is an error or adjustment, it could reduce, it could increase retained earnings, but those are not the norm. Those are not what we do when we adjust retained earnings. Also retained earnings could be restricted. What does it mean retained earnings restricted? It means we earn the money, but somehow it's restricted. And it could be restricted for two reasons. Either illegal reason, which is most state restrict the amount of treasury stock purchases to the amount of retained earnings. So for example, you cannot buy your treasury stock more than your retained earnings. Buy back your treasury stock. And if you're following the news these days, treasury stock, it's an important topic. Treasury stock is basically the same thing as the president called stock buyback, is when the company buyback their own stock. And when you buy back your own stock, you basically are rewarding yourself. How so? You buy your stock. It's like you're buying your own stuff. Like you have, like, assume you have a car and you buy your own car with your money, but you're not really buying it with your money. You're buying it with the company's money. So buyback is the president saying if we're going to be helping you as a company, you cannot have buyback. You cannot buyback your own stock to make yourself richer. Therefore, in some state, they have a legal restriction in the sense that you cannot buy treasury stock in excess of retained, in excess of your retained earnings, restrict that amount. And you could have also what's important and more relevant, and you see it more, is contractual regulation. Contractual regulation means you went to the bank to borrow money. That's fine. The bank might give you the money, but they might put restriction on you. What type of restriction? The bank might say, look, I'm going to give you money. But to protect myself, your retained earnings, you have to restrict retained earnings. For example, let's go back here. Remember what I told you after the company makes a profit here? If you remember after the company makes a profit, you remember they made a profit of 40,000 for the sake of my example. Let me restructure this example. Remember they made a profit of 40,000 and we said we're going to pay 25% or 10,000 of this retained earnings and keep the remaining 75%, 30,000. Now the bank might say you cannot pay 25%. You can only pay 10%. They'll put restriction on you. 10% means you can only pay 4,000 of your earnings and you have to keep 90,000, which is 36,000. So this is basically a contractual agreement. Now why would the bank do so? The bank would do so to protect themselves. The bank wants to make sure you don't pay out all your earnings in dividend. So they would restrict you in paying dividend. Why? Because they want to protect themselves. How do they protect themselves? Well, if you don't pay it out in dividend, you're going to have the money to pay interest because they want you to pay interest because you have a loan and they want the money back. They want you to pay the loan. So they want you to be able to pay the interest on the loan. So to guarantee that's going to happen, they would restrict you from paying out the earnings that you make from the company. So they put a contractual restriction. Now we looked at basically this is what I called a clean retained earnings statement. Basically simple clean retained earnings. So here's what happens sometimes. Sometimes the company might have an errors or mistakes. Errors or mistakes. So what's going to happen when you have an error from the prior period? So prior period. So from prior year, prior year. So what's going to happen when you have a mistake in the prior year, you cannot go back and change the prior year because the revenues and the expenses are gone. So what's going to happen? This error, it's going to go into retained earnings. So prior period adjustment are corrections of material errors in the past financial statements that result in the change in the beginning retained earnings. What does that mean? Let's assume you understated an expense or you overstated a revenue. Okay, or you overstated an expense or understated a revenue from the prior year. Well, for one reason or another, you made an innocent mistake or you made a mistake on purpose. It doesn't matter. Any of these mistakes from prior year if they are part of the prior year, the prior year is closed out. So the prior year is closed out. So what's going to happen when you make the adjustment? The adjustment is made into retained earnings. So you fix the beginning retained earnings. So let's look at an example to see what this looks like. And this topic is covered much more in intermediate accounting. Let's assume the retained earnings December 31st was 4,700. So this is the proper retained earnings as of last year. Then we find an error. Here's what's the error is cost of land incorrectly expensed net of tax $60 tax benefit net of tax benefit of $60. What does that mean? It means we expensed. So we bought a piece of land and for one reason or another. So we expense 200 net 200 and let's assume we paid cash we paid cash 200. This is what we did when we bought this land. The entry should have been debit land credit cash. So what we did is we expense the land by mistake. Now to fix this, we can't go back and take care of this expense because this expense is basically closed out. But this expense because we had an expense, we had an expense of $200 over reported. What happened is understate retained earnings by 200. So to fix the problem, we overstate retained earnings. So we'll take, we'll start with the normal retained earnings 4,700. We add the 200 because the expenses were overstated by 200. We reported 200 of expenses. Now we have retained earning as adjusted, the proper retained earning 4,900. Then we're back to normal ad net income minus dividend to get to to get to ending retained earning. And basically retained earning follow this base thing B, A, S, E. B is the beginning. A is the addition subtract then ending. So notice beginning plus addition, subtraction and ending that follow this acronym base, base acronym. So hopefully this will help you remember what the statement of retained earnings would look like base. It's a base. It's a very important statement as you will see later on in your accounting study. So don't underestimate understanding this concept. Take a look now at the statement of stockholder equity. The statement of stockholder equity is more inclusive than the statements of retained earnings, which is basically the statement of retained earnings sometime is included as part of stockholders equity. Because remember, when we think of stockholders equity, think of two components, retained earnings and common stock. Common stock and part of common stock is paid in capital. So now we're going to be looking at a statement of retained earnings. So statements of stockholders equity. Sorry, we looked at the statement of retained earnings. So bear in mind that to have a complete picture about this statements of stockholders equity, you need additional notes. So I don't have the notes. So some numbers may not make sense or we may not be able to know exactly what they are. We can speculate, but the purpose is to give you an overview about this statements of stockholders equity. So the statements of stockholders equity, they'll give you the number of shares, common shares, what you started with, the dollar amount, common stock, the beginning retained earnings, other. So this other could be accumulated other comprehensive income could be many things. So we don't know what this other is, but it's other sections of stockholders equity and total equity. So notice total equity, 128,249, the majority is one retained earnings to common stock. So notice retained earnings and common stock are the two main component in stockholders equity. Simply put, what the investors invested and what the company made and retained represent the majority of equity in any particular company. Then the statements of equity will show the changes in these accounts. For example, the company earned 48,351. That's going to increase retained earnings by that much because that income increases retained earnings. Then the company issued more stocks. Now notice here issuing more stocks, they issued 36,531. Notice here it's a negative 913. I don't know why there could be other issues. The company maybe issued them at a loss less than part. I don't know what the issue is. It's negative. Here we have some of the issue in stocks reduced retained earnings. It could be treasury stocks issued at a loss. We really don't know, but don't worry about this. Just know that you will have the details of the changes. So these numbers will have notes accompanying those numbers. Then we repurchase shares. They repurchase 246,496. Notice here the common stock went up. I believe it should have went down rather than go up. Maybe it's a mistake also, but it doesn't matter. Retained earnings went down by repurchasing shares. Maybe they're using a different method rather than the cost of treasury stock. It doesn't matter. And notice other was affected by 784 because notice here it says other. So we really don't know the details for this number, but the point is the statements of stockholder equity will have a detailed of the changes. But those details are not provided on this screen. Then we have cash dividend cash dividend should only reduces retained earnings. Okay. And then we have the ending balance for the number of shares will take the beginning plus the addition minus the subtraction. Then we will have the retained earning ending balance and the other ending balance and total stockholders equity. Basically, if you like this recording, please like it, share it for it in playlist. Visit my website for additional lectures, especially that I have other courses rather than just financial accounting. In the next recording, I would look at equity related ratios. They're not called equity related. I call them equity related such as earnings per share, dividend yield, PE ratio, the book value per share as well. As always, stay safe, study hard for your CPA exam and stay safe during those coronavirus days.