Gains and losses are the result of transactions that occur outside of a company’s normal line of business. A gain increases net income on the income statement, similar to revenue. A loss decreases net income, similar to an expense. Because net income flows through to retained earnings on the balance sheet, gains and losses have an equal effect on retained earnings as they do on net income.
Gains and Losses
A gain or loss generally occurs when you sell an asset, such as equipment, but may result from other transactions, such as property loss from a fire. If a company sells an asset for an amount that is greater than its book value, or value on the balance sheet, it reports a gain equal to the difference. If it sells an asset for less than book value, it reports a loss. For example, if a company sells equipment with a $40,000 book value for $100,000, it reports a $60,000 gain.
A company’s net income equals revenues plus gains minus expenses minus losses. When revenues and gains exceed expenses and losses, a company reports positive net income. When expenses and losses exceed revenue and gains, the company reports a net loss, which differs from the loss from selling an asset. For example, if a company has $100,000 in revenue, $20,000 in gains, $70,000 in expenses and $10,000 in losses, it reports $40,000 in net income, or $100,000 plus $20,000 minus $70,000 minus $10,000.
Retained earnings are an accumulation of a company’s net income that it has kept in its business since its beginning. A company’s net income increases retained earnings each period, while a net loss decreases retained earnings. A gain increases net income on the income statement and thus increases retained earnings. A loss decreases net income and thus decreases retained earnings. For example, if a company reports a $500 gain, its net income and retained earnings would increase by $500.
Gains and losses, such as a loss from a fire, are generally non-recurring items that affect retained earnings for only one period. It is important to keep this in mind when reviewing a company’s financials. For example, a company may increase its retained earnings by a high amount of net income, but most of the increase might be from a one-time gain. Although the gain increased the company’s retained earnings this period, the company might not maintain the same performance in future periods.
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