Fixing Incorrect Retained Earnings in QuickBooks: Use Profit and Loss Report for Verification

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Retained earnings in QuickBooks are critical to understanding your company’s financial position over time. Retained earnings represent the portion of a company's profit that is kept or "retained" in the business after dividends have been paid out to shareholders. It's an essential element for evaluating the health of your business as it grows and matures. However, incorrect retained earnings can cause confusion, errors in financial reporting, and mislead business decision-making.

This guide explores why retained earnings may appear incorrect in QuickBooks, how to verify the issue, and what steps you can take to ensure the Profit and Loss report accurately reflects your financial data.

What Are Retained Earnings?

Before diving into fixing retained earnings errors, it’s crucial to understand what retained earnings represent in your QuickBooks account.

Retained earnings are the cumulative net income (or loss) from the company’s inception, minus any dividends or owner’s withdrawals. It is shown in the equity section of the balance sheet and essentially accumulates the earnings that haven’t been distributed to owners or shareholders.

In QuickBooks, the retained earnings account automatically tracks profit or loss from previous years and rolls that forward into the new fiscal year.

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Common Causes of Incorrect Retained Earnings

Retained earnings in QuickBooks can become incorrect due to several reasons. Here are some of the most common causes:

Closing Date Errors: If your books weren’t closed correctly at the end of the fiscal year, retained earnings may not accurately reflect the prior year's profit or loss. This can be due to manual adjustments or entries that weren't captured at the closing date.
Incorrect Journal Entries: Manually entered journal entries directly affecting the retained earnings account can lead to discrepancies. Mistakes in journal entries, such as incorrect amounts or using the wrong account, can easily throw off retained earnings calculations.
Incorrect Fiscal Year Setup: If your fiscal year dates are set up incorrectly in QuickBooks, your Profit and Loss report will not align correctly with the retained earnings account, leading to inaccurate data.
Post-Year-End Adjustments: Adjustments made to accounts after the year-end closing date, but before the books are officially closed, can affect retained earnings. It’s essential to review these entries to ensure they’re applied correctly.
Unclosed Prior Years: If you haven’t closed out previous years in QuickBooks, profits or losses from those years might not be appropriately reflected in retained earnings.
Dividends/Owner’s Withdrawals Recorded Incorrectly: Failing to properly record dividends or withdrawals from retained earnings may result in retained earnings showing inaccurate values.

Symptoms of Incorrect Retained Earnings

Before troubleshooting retained earnings, look for some key signs that indicate discrepancies:

Balance Sheet Doesn’t Reconcile: The balance sheet equity section may not reconcile with the Profit and Loss report, especially when comparing retained earnings.
Profit or Loss Carryover Errors: If the profit or loss from the previous year is not carried over correctly to the retained earnings account, there’s likely an issue.
Owner’s Equity Inaccuracies: When the owner's equity is showing discrepancies, this can often signal a problem with retained earnings.

Verifying the Profit and Loss Report

The Profit and Loss (P&L) report in QuickBooks summarizes your income, expenses, and net profit or loss for a specific period. Comparing this report to your balance sheet helps in identifying retained earnings errors.

Here’s a step-by-step guide to verifying the accuracy of your Profit and Loss report, which will, in turn, ensure retained earnings are correct.

1. Run the Profit and Loss Report

To begin the verification process, generate the Profit and Loss report for the year in question:

QuickBooks Desktop: Go to the Reports menu, select Company & Financial, and then click Profit & Loss Standard. Choose the desired date range (for example, the fiscal year).
QuickBooks Online: Click on Reports from the left-hand menu, then select Profit and Loss under the Business Overview section. Set the appropriate date range for the fiscal year.

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Review the report for any unexpected variances or incorrect data. Focus on large or unusual numbers that might affect retained earnings.

2. Compare Year-End Totals

To ensure your retained earnings are correct, compare the net income from your P&L report to the retained earnings account in the balance sheet.

For example, if the net income for 2023 is $50,000, the retained earnings account should show that amount plus any previous retained earnings balance.

Balance Sheet Check: Go to the Reports menu and run a Balance Sheet Standard report for the last day of the fiscal year. The retained earnings should roll over properly into the new year.

If there is a mismatch, an error may have occurred during the year-end close or in data entry.

3. Review the Retained Earnings Account

Navigate to your retained earnings account in QuickBooks to view the transactions affecting it:

QuickBooks Desktop: Open the Chart of Accounts, find Retained Earnings, right-click, and select QuickReport.
QuickBooks Online: Open Accounting > Chart of Accounts, locate the retained earnings account, and click Run Report.

Look for any unusual transactions, manual adjustments, or journal entries that may have been incorrectly posted to retained earnings. These transactions should typically occur automatically when the year-end close is performed.

4. Check for Post-Year-End Adjustments

Ensure that no entries were made after the year-end close that would affect retained earnings for the previous year. This includes any backdated journal entries or transactions that should have been posted to the current fiscal year instead of the prior one.

If adjustments need to be made after the year-end close, ensure they are properly recorded as adjusting entries to avoid distorting retained earnings.

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5. Verify Owner’s Equity and Drawings

If the business is a sole proprietorship or partnership, owner’s equity and drawings should be tracked separately from retained earnings. Withdrawals by owners or partners must not be recorded in the retained earnings account.

In QuickBooks, ensure that withdrawals are recorded in the appropriate account. Any errors here can lead to discrepancies in retained earnings. This can be reviewed by running an Owner's Equity Report or by looking at transactions posted to the owner's equity account.

Fixing Retained Earnings Errors in QuickBooks

Once you've identified the source of the discrepancy, you’ll need to fix it. Below are common methods for correcting retained earnings errors in QuickBooks.

1. Correct Closing Date Errors

If the retained earnings account shows incorrect balances due to a closing date issue, you’ll need to re-close your books.

Go to Edit > Preferences, select Accounting, and click on Company Preferences.
Change or remove the closing date if needed. Once corrected, make sure to re-close your books properly.

Ensure all transactions are captured correctly before the year-end close to avoid discrepancies.

2. Fix Incorrect Journal Entries

If you discover that incorrect journal entries were made, you can delete or modify these entries. Be cautious, as making changes to journal entries can have a significant impact on your financial reports.

Open the journal entry, make the necessary changes, and save it.
Ensure that changes made to these entries align with the correct accounting periods to prevent issues in retained earnings.

3. Adjust Owner’s Withdrawals

Incorrect recording of dividends or owner’s withdrawals in retained earnings should be corrected by moving the transactions to the correct equity account. This can be done by creating a journal entry to transfer the funds.

For example:

Debit the retained earnings account and credit the owner's equity account.

Review the drawing accounts frequently to ensure accuracy.

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4. Reclassify Expenses and Income

Sometimes, expenses or income may be misclassified, causing the Profit and Loss report to inaccurately affect retained earnings. Use the Reclassify Transactions feature in QuickBooks Accountant to move transactions to the correct account.

Navigate to Accountant Tools > Reclassify Transactions and make the necessary adjustments.

This will ensure that income and expenses are recorded in the proper accounts, which in turn, reflects correctly in retained earnings.

5. Adjust Retained Earnings Manually

In rare cases, you may need to manually adjust the retained earnings account. This should be done cautiously and typically under the guidance of an accountant.

Create a journal entry where you debit or credit retained earnings and offset it with the appropriate equity or income account.

For example, if retained earnings are overstated by $5,000, you would create a journal entry that debits retained earnings by $5,000 and credits owner’s equity or another appropriate account.

Best Practices for Managing Retained Earnings and Profit & Loss Reports

To avoid retained earnings errors in the future, follow these best practices:

1. Close Your Books Annually

Always close your books at the end of each fiscal year. This ensures that the net income or loss for the year gets rolled over correctly into retained earnings. Set a closing date in QuickBooks and enable a password to prevent any future changes to the closed period.

2. Reconcile Your Accounts Monthly

Reconcile your accounts regularly to catch discrepancies early. Reconciliation helps ensure that income and expenses are properly classified and reported, minimizing the risk of retained earnings errors.

3. Review Financial Reports Regularly

Run and review your Profit and Loss and Balance Sheet reports regularly. This will help you catch issues early and address them before they become major problems at year-end.

4. Work with an Accountant

If your business’s financials are complex, working with a certified accountant or