Is Retained Earnings a Debit or Credit?

Retained earnings normally has a credit balance because it is part of shareholders’ equity, and credits increase equity. When a company earns net income, the closing entry adds that income to retained earnings with a credit; net losses and dividends reduce the account with debits. A debit entry during a period does not necessarily mean the account’s overall balance is a debit. If the ending balance is a debit, the company has an accumulated deficit because losses and distributions have exceeded profits retained over time. Retained earnings is an equity measure, not cash on hand, so its balance does not show how much money the company can spend.

Why Retained Earnings Normally Has a Credit Balance

Debit-and-credit rules depend on the type of account. Assets normally increase with debits, while liabilities and equity normally increase with credits. Revenue increases with credits, and expenses increase with debits. Since retained earnings is an equity account, a credit increases it and a debit decreases it. NetSuite’s overview includes retained earnings among the equity accounts increased by credits. Lumen Learning also explains the normal credit balance of equity accounts.

What Retained Earnings Represents

Retained earnings is the cumulative profit a corporation has kept in the business after accounting for losses and dividends. It is a permanent equity account, which means its balance carries forward from one accounting period to the next. A common calculation is:

Beginning retained earnings + net income − dividends = ending retained earnings

If the company records a net loss instead of net income, the loss reduces retained earnings. OpenStax’s explanation describes retained earnings as a primary part of earned capital that generally reflects cumulative net income less cumulative losses and dividends declared. It appears within stockholders’ equity on the financial statements.

Retained earnings does not show how much cash the company has in the bank. A company may have substantial retained earnings but little cash because it used profits to buy equipment, pay down debt, or build inventory. Borrowing or receiving investment can increase cash without generating retained earnings. Investopedia’s overview also distinguishes accumulated profits kept by the business from cash on hand.

How Closing Entries Affect Retained Earnings

At the end of an accounting period, revenue and expense accounts are closed because they track activity for that period only. Their net effect is transferred to retained earnings, often through an Income Summary account. This closing process explains why profits increase retained earnings through a credit and why revenue and expense balances do not carry into the next period.

• To close revenue, debit each revenue account and credit Income Summary.
• To close expenses, debit Income Summary and credit each expense account.
• If the result is net income, debit Income Summary and credit Retained Earnings.
• To close dividends, debit Retained Earnings and credit the Dividends account.

After revenue and expenses are closed, Income Summary contains the period’s net result. When revenue exceeds expenses, Income Summary has a credit balance equal to net income. Debiting Income Summary and crediting Retained Earnings transfers that profit into equity. When expenses exceed revenue, the company records a net loss, and the closing entry debits retained earnings to reflect the reduction in equity.

Dividends are closed separately because they are distributions to shareholders, not expenses used to calculate net income. A debit to retained earnings reduces the amount kept in the business, but it does not necessarily mean the company had a loss.

When Retained Earnings Is Debited

A debit to retained earnings is appropriate when an event reduces accumulated equity. Distinguish an entry that debits the account from its final balance: a company can record a debit during the period and still end with a credit balance.

Dividends

When a corporation distributes dividends, it reduces the earnings retained in the business. The distribution returns some accumulated earnings to shareholders rather than keeping them in the company. Dividends reduce retained earnings even when the company is profitable.

Net Losses

A net loss reduces retained earnings because expenses exceeded revenue for the period. Losses over multiple periods can eliminate an existing credit balance and result in a debit balance.

Corrections and Adjustments

Some accounting corrections or adjustments may require a debit to retained earnings. The appropriate entry depends on the circumstances and applicable accounting treatment. A debit in a particular entry does not by itself show that the account has an overall debit balance.

What a Debit Balance Means

A debit balance in retained earnings is generally called a deficit or accumulated deficit. It means cumulative losses and distributions have exceeded cumulative profits retained by the business. Retained earnings still has a normal credit balance; the debit balance indicates that the accumulated result has fallen below zero.

For example, suppose a company begins the year with retained earnings of $8,000 credit, records a $12,000 net loss, and pays no dividends. The loss reduces retained earnings by $12,000, leaving a $4,000 debit balance. The company has an accumulated deficit of $4,000. Learn more about negative retained earnings.

How Retained Earnings Differs from Revenue, Cash, and Paid-In Capital

Revenue is income earned during a particular accounting period. It is a temporary account that is closed at period-end. Retained earnings is a permanent equity account that carries forward the cumulative effect of past profits, losses, and dividends.

Cash is an asset and normally has a debit balance. Retained earnings is an equity account and normally has a credit balance. The accounts measure different things, so a large retained earnings balance does not mean the company has an equal amount of cash available.

Paid-in capital reflects amounts investors contribute in exchange for ownership. Retained earnings reflects profits the company generated and kept. Both are part of equity, but they come from different sources.

How to Apply the Debit-And-Credit Rule

Start by identifying retained earnings as an equity account, which normally has a credit balance. Then determine whether the event increases or decreases accumulated equity. Net income increases retained earnings through a credit, while net losses and dividends decrease it through debits. If the final balance is a debit, describe it as a deficit; the normal-balance rule has not changed.

*This article is for general informational purposes only and is not legal advice.