Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is the formula for retained earnings at the end of the year?

RE(EOY) = RE(BOY) + NI - DIV
RE(BOY) = RE(EOY) - NI + DIV
RE(EOY) = RE(BOY) - NI + DIV
RE(EOY) = RE(BOY) + DIV - NI

The correct answer is: RE(EOY) = RE(BOY) + NI - DIV

The formula for retained earnings at the end of the year is derived from the idea that retained earnings increase by the net income for the period and decrease by dividends paid to shareholders. This can be expressed mathematically as follows: Retained Earnings at End of Year (RE(EOY)) is equal to Retained Earnings at Beginning of Year (RE(BOY)) plus Net Income (NI) earned during the year, minus Dividends (DIV) distributed to shareholders. This formula reflects the flow of earnings within a company: starting with what was retained from the previous year, adding any profits made during the year, and subtracting any dividends paid out. Thus, the formula accurately captures the changes in retained earnings over the course of the financial year. This understanding is key when analyzing a company's retained earnings, as it highlights the important relationship between net income and dividends on shareholders' equity.