#Accounting#Financial Statements#Balance Sheet
Why do we call retained earnings a permanent account?
TL;DR Summary: Retained earnings is considered a permanent account because its balance rolls over from one accounting period to the next, unlike temporary accounts which are reset to zero at the end of each year.
Why do we call retained earnings a permanent account?
In accounting, accounts are generally divided into two main categories: temporary accounts and permanent accounts. Understanding the distinction helps clarify the role of retained earnings.
Temporary vs. Permanent Accounts
- Temporary Accounts: These include revenue, expense, and dividend (or withdrawal) accounts. At the end of each accounting period (usually a fiscal year), their balances are cleared out or "closed" to zero, transferring their net totals into retained earnings. This resets their tracking for the next period.
- Permanent Accounts: These include balance sheet accounts such as assets, liabilities, and stockholders' equity accounts (like common stock and retained earnings). Their balances are not zeroed out at year-end. Instead, the ending balance of one period simply becomes the beginning balance of the next period.
The Role of Retained Earnings
Retained earnings represents the cumulative amount of net income a company has earned minus the dividends it has paid out since its inception. Because it accumulates financial data over the entire lifespan of the business rather than just a single accounting period, its balance persists and rolls forward indefinitely, earning it the designation of a permanent account.