A balance sheet identifies a company’s assets and claims to those assets by creditors and owners at a specific date.
It
is a summary of the accounting equation and, like the equation, the
total of assets reported on the balance sheet must equal the combined
total of liabilities and owners’ equity. Exhibit below provides a
balance sheet for Mom’s Cookie Company at January 31, 2004.
It
reports dollar amounts associated with a company’s assets and the
sources of financing for those assets. It reports resources and claims
at a particular point in time rather than results of activities over a
period of time. A balance sheet usually is prepared at the end of each
fiscal period. It reports amounts of assets, liabilities, and owners’
equity at that time.
Profit
is earned by a business for its owners. It may be paid to the owners as
a return on their investments, or it may be retained in the business as
a means of acquiring additional assets. Thus, retained earnings is the
total amount of net income earned over the life of a company minus the
portion of net income paid out to owners.
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January is
the first month of operations of Mom’s Cookie Company, so the company
has earned net income for only one month. The income statement reported
net income for January of $1,700. None of the net income was paid out to
owners. Consequently, retained earnings at the end of January is
$1,700.
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Retained
earnings is separated from contributed capital in above Exhibit to
distinguish between the amount paid into the company by Maria and Stan
from the amount of profit earned and retained by the company. Amounts
paid to owners normally should come from the company’s profits. If a
company pays its owners more than the company has earned, it is
returning a portion of their investment to them. Owners need to know
whether amounts paid to them are a return on their investments, from
profits, or a return of their investments, from amounts invested
directly by the owners. Thus, Mom’s Cookie Company could pay Maria and
Stan up to $1,700 from profits earned in January as a return on their
investment. Any amount paid in excess of $1,700 would be a return of
their investment.
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