When a company earns net income, its retained earnings:

• A. Increase by the amount of net income, less any dividends declared
• B. Are transferred to common stock
• C. Remain unchanged
• D. Decrease by the amount of net income

Answer: (A)

Verified step by step guidance

1. Understand the concept of retained earnings: Retained earnings represent the cumulative amount of net income that a company has earned and retained (not distributed as dividends) over time.
2. Recognize the relationship between net income and retained earnings: When a company earns net income, it increases retained earnings because the company has generated additional profit.
3. Account for dividends: If the company declares dividends, the amount of dividends is subtracted from the net income before it is added to retained earnings. This reflects the portion of profits distributed to shareholders.
4. Analyze the options provided: The correct answer is the one that states retained earnings increase by the amount of net income, less any dividends declared. This aligns with the accounting treatment of retained earnings.
5. Conclude that retained earnings are not transferred to common stock, do not remain unchanged, and do not decrease by the amount of net income. These options are inconsistent with the definition and behavior of retained earnings.