Which of the following statements about retained earnings is true?
A It is the amount of creditors’ claims on assets.
B It is increased when treasury stock is bought.
C It is the amount of cash that has been retained from a company’s earnings.
D It is the amount of corporate earnings that have been reinvested in the business.
The correct answer and explanation is:
The correct answer is D: It is the amount of corporate earnings that have been reinvested in the business.
Retained earnings represent the cumulative amount of a company’s profits that are kept (retained) in the business instead of being paid out as dividends to shareholders. These earnings are reinvested to fund the company’s operations, growth, or to pay down debt. Retained earnings are reported on the balance sheet under shareholders’ equity, and they reflect the portion of profits not distributed to owners but instead held for future use in the company.
Option A is incorrect because creditors’ claims on assets are related to liabilities, not retained earnings. Liabilities represent obligations a company must fulfill, whereas retained earnings are part of equity, representing ownership value in the company.
Option B is also incorrect. Treasury stock refers to shares that were repurchased by the company. When a company buys back its own stock, it reduces the total outstanding shares, but this transaction does not directly increase retained earnings. In fact, the purchase of treasury stock reduces the company’s cash reserves, which could indirectly reduce retained earnings if the repurchased stock was paid for out of previously retained profits.
Option C is inaccurate because retained earnings do not refer to cash. While retained earnings reflect profits kept in the business, this does not mean the company has that amount of cash available. Profits can be retained in various forms, such as accounts receivable, inventory, or other assets, and are not necessarily held in cash.
Thus, D is the most accurate statement, as it correctly describes retained earnings as the portion of corporate earnings that is not distributed but reinvested back into the business.