Which of the following best describes retained earnings?
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A. B. C. D. E.E
Retained earnings represent the earned capital of a firm. It consists of the accumulated undistributed earnings (net profits, less cash dividends) of a firm since inception.
The correct answer is E. Retained earnings represent the cumulative net profits of a firm since inception, minus cumulative dividends paid to common stockholders.
Retained earnings are an important financial concept used in accounting to measure the accumulated profits of a company over time. They represent the portion of net income that is retained within the company after paying out dividends to shareholders.
To provide a detailed explanation, let's break down the answer options:
A. All of these answers: This is not the best answer because it implies that all the answer options are correct, which is not the case.
B. None of these answers: This is not the best answer because there is at least one correct answer among the options.
C. Retained earnings represent the cumulative net profits of a firm since inception: This statement is partially correct. Retained earnings do represent the cumulative net profits of a firm since inception, but it fails to account for any dividends paid to common stockholders. Therefore, it is not the best answer.
D. Retained earnings represent the sum total of cash obtained from the sale of common stock to investors: This statement is incorrect. Retained earnings are not directly related to the sale of common stock. Instead, they are derived from the company's net profits.
E. Retained earnings represent the cumulative net profits of a firm since inception, minus cumulative dividends paid to common stockholders: This is the best answer among the options provided. It accurately describes retained earnings as the cumulative net profits of a company since its inception, while also taking into account the deduction of dividends paid to common stockholders. Retained earnings increase when the company generates profits and decrease when dividends are distributed to shareholders.
In summary, retained earnings represent the cumulative net profits of a firm since its inception, minus the cumulative dividends paid to common stockholders. It is important to understand this concept as it reflects the amount of earnings that a company has retained for reinvestment in its operations or for future distribution to shareholders.