Retained earnings is not an asset. It is an equity account, the cumulative net income a corporation has kept rather than distributed to its owners, reported inside the equity section of the balance sheet. An asset is a present right of an entity to an economic benefit, while equity is the residual interest in the assets of an entity that remains after deducting its liabilities (FASB Concepts Statement No. 8, Chapter 4, Elements of Financial Statements, paragraphs E16 and E61). Retained earnings is part of that residual, so it can never be one of the assets the residual is measured against.
The Balance Is Not a Pool of Money
A large balance is not money the corporation can spend. Retained earnings is an equity balance rather than a fund, as the statement of retained earnings works through, and what makes it feel like an asset is that the number can be large while the bank is thin.
Say a corporation’s year-end balance sheet reports the two balances below.
Retained earnings 430,000
Cash 18,000Both are correct at the same date, and nothing has gone missing between them. The first says the corporation has earned that much more than it has ever distributed to its owners. The second says how much cash the corporation held at that date. The cash went out again as it arrived, into equipment, inventory and debt principal, and none of those outlays reduces the retained earnings balance, because the account counts what was earned and never paid out to owners, not what is left to spend.
The Claim Sits Opposite the Assets It Paid For
Retained earnings is reported on the claims side of the balance sheet, beside liabilities and the other equity captions, carrying the credit balance that side normally takes, as the normal balance of retained earnings sets out. The assets those earnings paid for are reported on the other side. One side lists what the business holds, the other lists who has a call on it, so a figure living among the claims cannot also be one of the things claimed. The answer is structural rather than a matter of degree: retained earnings is on the wrong side of the sheet to be an asset at all, and what shares that side with it is in stockholder equity.
It Is Not a Liability Either
A second reading gets the side right and the element wrong, treating the balance as money the corporation owes its shareholders. A liability is a present obligation of an entity to transfer an economic benefit (FASB Concepts Statement No. 8, Chapter 4, paragraph E37), and undistributed earnings oblige the corporation to transfer nothing to anyone. That obligation begins only when the board declares a dividend, the entry worked through in the dividend payable account.
Common Questions
Are Retained Earnings a Current Asset?
No, and the classification never reaches the account. Current and noncurrent is a sorting applied to two elements only. Financial position is revealed in a presentation of the assets and liabilities of the enterprise, and in the statements of manufacturing, trading and service enterprises those assets and liabilities are generally classified and segregated (ARB No. 43, Chapter 3A, paragraph 3). Equity captions are not sorted that way, so retained earnings is neither current nor noncurrent. What the current test does cover is set out in current assets.
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