Calculating Net Income by looking at change in Retained Earnings

CFA Level I FRA
#1

Question regarding a practice problem in CFAI Understanding Cash Flow Statements. Basically, for this specific question, it says that to calculate Net Income, you would need to

  1. find the increase in retained earnings (eg from year 2009 to 2010)

  2. add cash dividends paid (in 2010)

So Net Income = change in retained earnings + cash dividends paid.

I am curious as to why you would add the cash dividends paid to get net income. Won’t the cash dividends paid already be reflected in a decreased retained earnings?

#2

RE2010 = RE2009 +net income - cash dividends

RE2010 - RE2009 = net income - cash dividends

RE2010 - RE2009 + cash dividends = net income

#3

Dividends are paid post net income. Remainder would then go into Retained Earnings, so it’s not entirely reflective of a ‘decrease’ in retained earnings because it’s never accounted for to begin with. Hence you adding it back in.

#4

There. That’s better.

#5

I stand corrected.

Next time, beer and sammiches on me!!!

#6

As an example, imagine a company earns $100 in net income. They then decide to declare a $25 dividend (which is of course earnings that are not retained). This leaves $75 in retained earnings. Thus, in order to calculate net income from retained earnings, the dividend needs to be added back: $75 retained earnings + $25 dividend = $100 net income.