Hello, welcome back to this lecture today My name is Justin light from think numbers and in this lecture today we're going to be talking about the retained earnings account, which is a specific owner's equity account, but it requires a lecture on its own because there is a lot more to this account than first appears. And it's important to understand this. So first, let's understand what is the retained earnings account which sits on the balance sheet. It's actually the cumulative profits or losses made since the business commenced, plus any current year profits, less any dividends. So again, it is the opening balance for the year. Now if you started the business, you don't have an opening balance because there is no profit if you've started a business from scratch, but if you've started last year, the year before, then you can have an opening balance which is the closing balance.
Last year, so there will be profit sitting the opening balance, you then have to add the profits or losses for the current period. And that is effectively your p&l. So everything that is sitting in your current profit and loss statement. So if it's if it's in profit, it's a credit balance. If it's in a loss position, it's a debit balance and a debit balance will mean that you've got more costs than you do revenues. So you take your opening balance for retained earnings, you add your current profits and losses, which is remember, profits are revenue, less expenses, so all of your revenues, less all of your expenses.
You then take off any dividends that have been declared in the current year, declared and not paid, remember, so they don't have to be paid, they just have to be declared and then that you end up with a closing balance for your retained earnings. So let's just illustrate that again, in another way. Just so you can Understand this. So say for example, you've just started a business. And it's year one of the business, you've literally just started a brand new organization. In the first year, you actually make $100 profit, let's just say.
So, by the end of the year, you started off with a zero opening balance, you made $100 profit for the year, let's just assume you didn't declare any dividends for that year. And so you closed mountains for the first year is $100. Because of the profit retained earnings is $100. YouTube begins in this year, you're going to make $150 in the second year, but the opening balance is actually the hundred dollars from the previous year, you're also going to add in $150 for the second year. And so your closing balance in the sick by the end of the second year, is actually $250. So you can see the way that retained earnings Words is it's actually accumulation since we started the business now, eatery begins.
What do you think the opening balances, it's actually going to be the $250 from YouTube. But in the third year, we make it further $200 profit. And we actually this year, we decided to take a dividend out of $100. So if we look at the third year, we have $100. From the first year, we made $150 in the second year, in the current year, we're now making $200. And we're actually going to take out $100 is a dividend.
So the opening balance for the third year was the 250. For me to closing balance with an add on the $200 profit for the current year, and we take off $100 for the dividend. So the closing balance in the third year is actually going to be $350. So you can see the way it works is it all depends on how much profit making for the year and how much dividends you're taking out. Now, if this was a loss making position where you're not actually making profit, it would actually be reducing your retained earnings balance and putting it into a debit balance position. So, it's still exactly the same application of the way I've explained it here.
It's just it would be the opposite direction, because you've got too much costs as opposed to revenues. Okay, so that's how retained earnings works. Feel free to review this. Again, it's important to understand this because this is the link between the balance sheet and the profit and loss statement. Because when you in order for the equation to work, the profit needs to be sitting in retained earnings balance in order for the balance sheet to balance Okay, and that actual profit will be the makeup of all your revenues and all your expenses that are sitting on your profit loss for that current year. But it also includes any opening balance Previous use as well.
Okay, so just to sum up, retained earnings is the cumulative profits and losses made since the business commence plus any current year profits or losses, less any dividends. So, that is the owner's equity side now fully covered. We're now going to dig into a bit more about general journals. And then we're going to actually go into a live practical case study on shop fill automotive. Okay, we'll see you in the next lecture.