A credit is a normal balance in the retained earnings account. If it is so, this fact denotes that a business has managed to generate some profit over its existence.
Explanation:
Retained earnings, also known as retained capital, stand for the funds that a company possesses after it has dispersed appropriate dividends from its income. Any company is free to use its retained capital for investing purposes, covering debts, and others. The components of retained earnings include the previous capital, income, and dividends.
If one wants to calculate the retained earnings over a particular period, it is necessary to add net income to the amount of retained earnings over the previous period and subtract dividends from that sum. This simple formula looks as follows:
beginning retained earnings + net income – dividends.
Every company can have either negative or positive retained earnings. They are negative when a business has to pay more dividends in comparison with the income that it has obtained during its life. In addition to that, the positive retained capital denotes that the company’s profit is higher than the dividends to be paid.
It is not surprising that the two phenomena above imply different balances. Thus, positive earnings appear as a credit balance, while a debit one involves the negative retained capital. Consequently, it seems easy to define whether debit or credit is the retained earnings normal balance.
The fact that credit is the normal balance is logical because all revenue accounts have balances of this kind, while debit balances are characteristic features of expense accounts. In addition to that, a debit balance in retained earnings is called an accumulated deficit, which emphasizes the harmful impact of this phenomenon.