What does the Statement of Retained Earnings equation calculate?

The Statement of Retained Earnings equation calculates the amount of retained earnings available at the end of a financial period. The correct formulation—Beginning Retained Earnings plus Net Income minus Dividends—provides a clear picture of how retained earnings change over time.

The starting point is the beginning retained earnings, which reflects the cumulative earnings that have been retained rather than paid out as dividends. When a company earns net income during the period, that amount is added to the retained earnings, reflecting the increase in the company's profitability. Conversely, dividends represent payments to shareholders, which reduce the retained earnings since these funds are distributed rather than retained within the company.

Thus, the equation accounts for the changes caused by profits being reinvested versus those being distributed, culminating in the ending retained earnings for the period. This understanding is crucial as retained earnings play a vital role in the overall equity structure of a company, indicating how much profit has been reinvested in the business.