Revenues are the sums that businesses receive in exchange for providing their customers with their goods and/or services, while expenses are the sums that businesses spent running their revenue-producing operations. Revenues minus expenses equal the business's net income, either the increase in its financial holdings or the decrease in the same depending on the business's performance.
At the end of each period, a business sums up its revenues and expenses as its net income for that period. The business then either distributes this to the business's owners or allocates it to the retained earnings account to reinvest it into the business's operations. Dividends and similar transactions do not count as part of the business's expenses because they are not costs of running its operations.
Retained earnings is an equity account that represents the accumulated portions of net income that a business reinvests into its operations. It is something of a catch-all term for all of the income that a business earns but does not intend to distribute to its owners. Retained earnings is a normal equity account and has a credit balance when it is positive.
Debit and Credit
Debit and credit refer to the left and right sides of the accounting ledger. All accounts, including retained earnings, possess a normal, positive balance that displays as either a debit or a credit. When their values increase, those increases appear on the side that is normal to that account while decreases appear on the opposite side. Each accounting transaction appears as an even sum recorded on each side of the ledger. For example, if a business purchased $20,000 in supplies, paid $18,000 in cash, and promises to pay the rest later, the business records a $20,000 debit to supplies, a $18,000 credit to cash, and creates an account payable with a $2,000 credit balance.
Retained Earnings' Normal State
Equity represents the portion of the business's assets that its owners have invested or reinvested into the business rather than acquiring through incurring debts and obligations to other entities. Equity accounts possess credit balances when positive and debit balances when negative. In most cases, retained earnings has a credit balance, receiving a credit when it increases and a debit when it decreases. However, it is possible that a business distributes more to its owners than it earns and ends up with negative retained earnings with a debit balance.
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.