Question

1. Which of the following is CORRECT?
A. Retained Earnings (2015) = Retained Earnings (2014) – Net Income (2015)
+ Dividends (2015)
B. Retained Earnings (2014) = Retained Earnings (2015) + Net Income (2014)
– Dividends (2014)
C. Retained Earnings (2015) = Retained Earnings (2014) + Net Income (2015)
– Dividends (2015)
D. Retained Earnings (2014) = Retained Earnings (2015) + Net Income (2014)
+ Dividends (2014)

Answer 1

Imagine a company has a constant value of common stock outstanding say $ K

Let the Retained Earnings at the end of 2014 be $ RE2014

Therefore, Shareholder's Equity at the end of 2014 = K + RE2014

If the company makes a profit of NI in 2015 and pays out dividend D from the same, we have at the end of 2015 shareholder's equity equal to:

Shareholder's Equity = K + RE2014 + NI - D

K + RE2015 (where K the common stock outstanding is constant and RE2015 is this year's retained earnings) = K + RE2014 + NI - D

Canceling $ K from both sides we get:

RE2015 = RE2014 + NI - D

Hence, the correct option is (C).