What happens to retained earnings when net income increases due to a decrease in expenses?

When net income increases due to a decrease in expenses, retained earnings increase. This is because retained earnings are the cumulative amount of net income that a company has retained, rather than distributed as dividends to shareholders.

When expenses decrease, it leads to an increase in net income. This higher net income, once calculated, adds to the retained earnings. The retained earnings account reflects the profits that have been reinvested into the business over time. Therefore, any increase in net income directly contributes to an increase in retained earnings, which is an essential component of shareholders' equity on the balance sheet.

This understanding is crucial in accounting as it illustrates the link between operational performance (as reflected in net income) and the company’s equity structure, helping stakeholders assess the company’s financial health and growth potential.