Why Is My Retained Earnings Balance Wrong?
One of the Most Misunderstood Accounts on the Balance Sheet
Few Balance Sheet accounts create more confusion than Retained Earnings.
Business owners often discover a Retained Earnings balance that seems impossible to explain.
Sometimes it suddenly changes.
Sometimes it doesn’t agree with prior years.
Sometimes a CPA asks questions no one can answer.
Other times it simply doesn’t make sense.
Retained Earnings should not be viewed as just another accounting account.
It represents the accumulated results of your business after profits, losses, distributions, and certain accounting adjustments over time.
When the balance appears incorrect, the problem is often much larger than the Retained Earnings account itself.
At Polaris Tax & Accounting, inaccurate Retained Earnings is one of the most common symptoms we encounter during Accounting Recovery engagements.
Quick Answer
Retained Earnings usually becomes incorrect because of historical accounting errors rather than problems with the Retained Earnings account itself. Common causes include incorrect prior-year journal entries, changes made to closed accounting periods, duplicate transactions, improper owner distributions, software conversions, and unsupported Balance Sheet adjustments. The solution is identifying the underlying accounting issue—not simply changing the Retained Earnings balance.
What Is Retained Earnings?
Retained Earnings represents the cumulative profits and losses of a business that have remained in the company after considering owner distributions, dividends, and certain accounting adjustments.
Each year, current-year net income generally flows into Retained Earnings at year-end.
As a result, the account reflects years of business activity rather than transactions from a single accounting period.
Because Retained Earnings accumulates historical financial information, accounting errors from prior years frequently appear here long after they originally occurred.
Signs Your Retained Earnings May Be Wrong
- The balance changes unexpectedly.
- Your CPA cannot explain the account.
- Retained Earnings differs from prior financial statements.
- Owner distributions appear incorrect.
- Balance Sheet totals no longer make sense.
- QuickBooks or Xero shows unusual year-end changes.
- Historical accounting adjustments have been made repeatedly.
- The business changed accounting software.
Common Causes of Incorrect Retained Earnings
| Cause | Potential Result |
|---|---|
| Historical journal entries | Prior-year equity becomes distorted. |
| Editing closed accounting periods | Retained Earnings changes unexpectedly. |
| Duplicate revenue or expense entries | Historical profits become inaccurate. |
| Improper owner distributions | Equity reporting becomes unreliable. |
| Software conversion errors | Beginning balances transfer incorrectly. |
| Unsupported Balance Sheet adjustments | Retained Earnings no longer reflects actual business history. |
| Improper year-end closing entries | Cumulative equity becomes inaccurate. |
Should You Just Change the Retained Earnings Balance?
Usually not.
One of the most common mistakes businesses make is posting a journal entry directly to Retained Earnings simply because the balance appears incorrect.
Doing so may temporarily make the Balance Sheet look better while leaving the actual accounting problem unresolved.
Instead, the underlying cause should be identified.
Questions worth asking include:
- Were prior years changed?
- Were historical journal entries posted correctly?
- Do prior financial statements agree with current reports?
- Have owner distributions been classified properly?
- Did the accounting software convert correctly?
The objective is understanding why Retained Earnings changed—not simply forcing the balance to agree with expectations.
Can Retained Earnings Affect Taxes?
Sometimes.
Retained Earnings itself generally does not determine taxable income.
However, the accounting errors that create incorrect Retained Earnings balances may also affect revenue, expenses, depreciation, owner distributions, payroll accounting, or other items that influence tax reporting.
Whether amended tax returns are necessary depends on the specific accounting issues identified during the recovery process.
Our Process
- Perform an Accounting Diagnostic™.
- Review historical financial statements.
- Analyze prior-year journal entries.
- Evaluate owner equity activity.
- Identify accounting events affecting Retained Earnings.
- Determine whether Accounting Recovery is appropriate.
- Validate corrected financial reporting.
Frequently Asked Questions
Should Retained Earnings change every month?
Generally, no. Retained Earnings typically changes because of year-end closing processes, prior-period adjustments, owner transactions, or corrections affecting historical accounting.
Can QuickBooks or Xero calculate Retained Earnings incorrectly?
The software generally calculates Retained Earnings based on the accounting data entered into the system. When the balance appears incorrect, the underlying accounting records usually require review.
Can I delete Retained Earnings?
No. Retained Earnings is a fundamental equity account. If the balance appears incorrect, the cause should be investigated rather than eliminating the account.
Will fixing Retained Earnings require changing prior years?
Possibly. The appropriate solution depends on the source of the accounting issue and should be determined after evaluating the historical records.
Restore Confidence in Your Balance Sheet
If your Retained Earnings balance cannot be explained, don’t assume the problem is isolated to one account.
It often signals broader accounting issues that deserve professional review.
Our Accounting Diagnostic™ evaluates the condition of your accounting records, identifies material financial reporting issues, and develops a structured roadmap for restoring confidence in your Balance Sheet and financial statements.