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Retained Earnings is generally a credit. It will be “credited if its balance increases” and “debited if its balance decreases”.
To help you understand the statement given above, it is important for you to first interpret the meaning of retained earnings.
Meaning of Retained Earnings
Retained Earnings is the accumulated net income of an entity at the end of an accounting period that is retained by it to meet any future contingencies, invest in the expansion activities, payment of dividends to its shareholders, etc.
Retained Earnings = Opening Retained Earnings +/- Net Profit/(Loss) during the current period – Dividend paid in the current period +/- Prior period adjustments, etc.
If the balance of retained earnings is negative, then it is referred to as accumulated losses/deficit, retained losses.
Why is Retained Earnings generally credited?
Retained Earnings are a part of “Shareholders Equity” presented on the “Liabilities side” of the balance sheet.
This is because it indicates the company’s liability to the owners or shareholders. The company cannot utilize the retained earnings until it is approved by its shareholders.
Also, the modern approach of accounting for liabilities states-
Credit the increase in liability, Debit the decrease in liability.
Therefore, considering it as a liability and following the modern approach of accounting, we can conclude that retained earnings will be generally credited.
It will generally show a credit balance.
Now, moving forward let me help you understand the instances in which retained earnings are credited or debited.
When is Retained Earnings credited or debited?
1. Retained Earnings are credited with the Net Profit earned during the current period. Crediting the retained earnings will increase its balance.
Samsung Inc. earned a net profit of 500,000 during the accounting period Jan-Dec 20×1.
Journalizing this transaction for transferring the net profit earned to retained earnings will be-
|Net profit||Debit||500,000||Transferring net profit earned to retained earnings|
|To Retained Earnings||Credit||500,000||Credit the increase in the balance of retained earnings|
2. Some instances which reduce the balance of retained earnings are-
a. Net loss during the current period
b. Dividend payable
c. Bonus Shares issued, etc.
Retained Earnings will be debited with these transactions.
Shareholders of Apple Inc. approve the dividend declared by the board of directors amounting to 100,000. So, the journal entry for the dividend payable by Apple Inc. will be-
|Retained Earnings||Debit||100,000||Debit the decrease in the balance of retained earnings|
|To Dividend Payable||Credit||100,000||Credit the increase in liability|