Is Retained Earnings a Debit or Credit?
Retained earnings is a credit. It is an equity account holding cumulative profit that has not been paid out, so it increases with a credit when the business earns income and decreases with a debit when it loses money or pays owners. Its normal balance is a credit, and it is reported on the balance sheet.
- Account category
- Equity
- Normal balance
- Credit (Cr)
- Increases with
- Increase (Cr)
- Decreases with
- Decrease (Dr)
- Financial statement
- Balance sheet
| Debit (Dr) | Credit (Cr) |
|---|---|
| Decrease (Dr) | Increase (Cr) |
| Distributions and losses45,000.00 | Net income closed out92,000.00 |
Classifying one account is easy. Ledger IQ classifies the whole trial balance.
Try it freeRetained earnings on a trial balance
| Acct # | Account | Debit | Credit |
|---|---|---|---|
| 1000 | Cash | 48,200.00 | |
| 1200 | Accounts receivable | 86,400.00 | |
| 1250 | Allowance for doubtful accounts | 4,200.00 | |
| 1300 | Inventory | 72,500.00 | |
| 1400 | Prepaid expenses | 9,800.00 | |
| 1450 | Notes receivable | 15,000.00 | |
| 1460 | Due from shareholder | 12,000.00 | |
| 1500 | Equipment | 120,000.00 | |
| 1510 | Accumulated depreciation | 38,000.00 | |
| 1700 | Goodwill | 40,000.00 | |
| 1710 | Accumulated amortization | 8,000.00 | |
| 2000 | Accounts payable | 31,500.00 | |
| 2050 | Credit card payable | 6,300.00 | |
| 2100 | Accrued expenses | 11,200.00 | |
| 2150 | Payroll liabilities | 7,400.00 | |
| 2200 | Sales tax payable | 4,100.00 | |
| 2300 | Unearned revenue | 18,000.00 | |
| 2400 | Notes payable | 85,000.00 | |
| 2450 | Due to shareholder | 20,000.00 | |
| 3000 | Common stock | 50,000.00 | |
| 3100 | Additional paid-in capital | 35,000.00 | |
| 3900 | Retained earnings (the account this page is about) | 92,000.00 | |
| 3950 | Shareholder distributions | 45,000.00 | |
| 4000 | Sales revenue | 550,000.00 | |
| 4100 | Sales returns and allowances | 12,000.00 | |
| 4200 | Interest income | 1,200.00 | |
| 5000 | Cost of goods sold | 240,000.00 | |
| 6000 | Salaries and wages | 96,000.00 | |
| 6050 | Officer compensation | 60,000.00 | |
| 6100 | Rent expense | 36,000.00 | |
| 6150 | Insurance expense | 14,400.00 | |
| 6300 | Depreciation expense | 19,000.00 | |
| 6450 | Interest expense | 6,800.00 | |
| 6900 | Other operating expenses | 28,800.00 | |
| Total | 961,900.00 | 961,900.00 |
Example journal entries
| Account | Debit | Credit |
|---|---|---|
| Income summary | 42,700.00 | |
| Retained earnings | 42,700.00 |
| Account | Debit | Credit |
|---|---|---|
| Retained earnings | 45,000.00 | |
| Shareholder distributions | 45,000.00 |
| Account | Debit | Credit |
|---|---|---|
| Retained earnings | 3,200.00 | |
| Accrued expenses | 3,200.00 |
Why it works that way
Equity is what the owners have in the business, and it sits on the right side of the accounting equation with liabilities. The right side increases with credits. Retained earnings is the part of equity the business generated itself rather than receiving from owners, so profit credits it and losses debit it.
A debit balance is possible and has a name: accumulated deficit. It means cumulative losses and distributions have exceeded cumulative profits, which is common in early years and not an error by itself.
The roll forward is the whole account
Retained earnings should never be a number anyone types. It is derived:
Beginning retained earnings, plus net income, less distributions or dividends, plus or minus prior period adjustments, equals ending retained earnings.
That is the Schedule M-2 computation on Form 1120, and it is the check that catches most Schedule L problems. When the balance sheet does not tie, the fastest test is to compute what ending retained earnings should be from that formula and compare it to what is on the books. A difference that equals the distributions means distributions were never closed out. A difference that equals net income means the year was never closed.
Where it goes wrong
Plugging it. Forcing retained earnings to make the balance sheet balance hides the real error somewhere else and carries it forward into every later year. Drake will do this automatically through autobalance unless the feature is turned off.
Mixing distributions into it during the year. Distributions belong in their own account until closing, so the activity stays visible for Schedule M-2 and for basis tracking.
Posting current year adjustments to it. An adjustment that belongs in this year's income statement does not belong in equity. Only genuine prior period corrections go to retained earnings, and if the prior year return was filed on the old figures the client needs to know.
S corporations: retained earnings is not AAA
On an 1120S, book retained earnings and the accumulated adjustments account are different figures that often drift apart. AAA follows tax rules: it increases by separately and nonseparately stated income, decreases for losses, nondeductible expenses and distributions, and it has a different starting point for a corporation that converted from C status.
Schedule M-2 on the 1120S tracks AAA, not book retained earnings, which is why those two columns frequently fail to match the balance sheet. That is expected rather than wrong.
Where it fits in the accounting equation
Tax return treatment
| Form | Line |
|---|---|
| Form 1120 | Schedule L line 25, unappropriated retained earnings, with the roll forward on Schedule M-2 |
| Form 1120S | Schedule L line 24, with AAA tracked separately on Schedule M-2 |
| Form 1065 | Schedule L line 21, through partner capital accounts rather than retained earnings |
Common questions
Is retained earnings a debit or credit?
A credit under normal circumstances, because it is an equity account. Net income credits it and losses and distributions debit it. A net debit balance is an accumulated deficit, which is a real condition rather than a mistake.
How do I calculate ending retained earnings?
Beginning retained earnings plus net income, less distributions or dividends, plus or minus prior period adjustments. That is the Schedule M-2 roll forward, and it should always be derived rather than typed into the balance sheet.
Why does retained earnings not match Schedule M-2 on an 1120S?
Because Schedule M-2 on an 1120S tracks the accumulated adjustments account, which follows tax rules, while the balance sheet carries book retained earnings. Nondeductible expenses, different depreciation and a prior C corporation history all drive the two apart, and the difference is expected.
Can retained earnings be negative?
Yes. It is called an accumulated deficit and simply means cumulative losses and distributions exceed cumulative profit. On an S corporation it also raises the question of whether distributions have exceeded basis, which has consequences for the shareholder.
Related answers
Go deeper
This page is the short answer. These articles work through the same ground in detail.
Last reviewed October 18, 2026.