Which statement about retained earnings is true?

Which statement about retained earnings is true?

• A. Retained earnings are unaffected by net income.
• B. Retained earnings are recorded as cash.
• C. Retained earnings increase when net income is reinvested and decrease when dividends are paid.
• D. Retained earnings decrease when profits rise.

Answer: (C)

Retained earnings represent the cumulative profits kept in the business rather than paid out as dividends. They rise when the company earns net income and that income is not distributed as dividends (i.e., it’s reinvested in the company), and they fall when dividends are paid to shareholders. They are an equity account, not cash, so profits don’t become cash automatically; they become retained earnings unless distributed. For example, if you start with retained earnings of 500, net income is 100, and you pay dividends of 30, ending retained earnings would be 570 (500 + 100 − 30). This shows how reinvesting net income increases retained earnings, while paying dividends reduces them. That’s why this statement is the true description: it captures the direct relationship between net income, reinvestment, and dividends in shaping retained earnings.

Retained earnings represent the cumulative profits kept in the business rather than paid out as dividends. They rise when the company earns net income and that income is not distributed as dividends (i.e., it’s reinvested in the company), and they fall when dividends are paid to shareholders. They are an equity account, not cash, so profits don’t become cash automatically; they become retained earnings unless distributed.

For example, if you start with retained earnings of 500, net income is 100, and you pay dividends of 30, ending retained earnings would be 570 (500 + 100 − 30). This shows how reinvesting net income increases retained earnings, while paying dividends reduces them.

That’s why this statement is the true description: it captures the direct relationship between net income, reinvestment, and dividends in shaping retained earnings.