The operating activities of the firm generate retained earnings. The client is invoiced and funds are received when a license is sold or a service is performed. In effect this process adds to the owner’s wealth. Similarly, expenses incurred to perform the company’s services decrease shareholder wealth.
This relation can be expressed as: Retained Earnings = Revenue minus Expenses. Whether it results in an increase or a decrease in the owner’s wealth, it has a net income effect, which is the term we will use to describe retained earnings.
As every transaction during month one (M1) is a typical transaction, all typical transactions enter the Retained Earnings table below.
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