Business operations are run with the intent to produce profits, profits being an increase in the businesses' financial circumstances. Profits are created when revenues earned through sales or fees exceed the expenses of running the business in much the same way as losses are created when expenses exceed revenues. Many, but not all, business transactions impact listings on either the balance sheet or the income statement -- royalties impact the income statement while dividends can impact either the income statement or the retained earnings statement, depending on the accountant's perspective.
Revenues are the sums that a business receives in exchange for providing its customers with its products while expenses are the sums that a business spends in order to acquire those same products and turn them to actual revenue. Revenues minus expenses is equal to the business's change in financial circumstances, or net income. Together, revenues and expenses comprise a business's operations but are not solely responsible for all changes in its financial circumstances. Changes arising out of nonoperational activities such as gains and losses on disposal of assets are not considered either revenues or expenses.
Retained Earnings Statement
Retained earnings is the account that records the accumulated earnings that the business chooses to reinvest into its operations rather than distribute to its shareholders as dividends. Its change during the period is recorded on the retained earnings statement and is the result of net income minus dividends declared for the period. Dividends are listed on the retained earning statement because they do not arise out of the business's operations.
From the perspective of the investor who receives dividends paid on its investments, dividends are considered revenue. From the perspective of the corporation that declares and then pays out dividends, it is a deduction to retained earnings and the corresponding creation of a current liability called dividends payable. Dividends are different from royalties in that they do not impact the corporation's income statement and thus do not color its performance for the period.
Similar to dividends, royalties are likewise revenue from the perspective of who receives them. In contrast to dividends, royalties are considered an expense by whomever pays them because the business is paying to use someone's intellectual property in order to produce profits. As such, royalties do appear on the business's income statement and decrease operating net income for the period.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.