What happens to retained earnings when a company incurs a net loss?

When a company incurs a net loss, retained earnings, which represent the accumulated profits that have been retained in the business rather than distributed to shareholders as dividends, will decrease. This is because a net loss reduces the overall equity of the company, and since retained earnings are part of total equity, any loss will directly impact them.

To elaborate, retained earnings are affected by the company's profitability over time; thus, if the company experiences a loss, that loss is deducted from the previously accumulated retained earnings. Therefore, it is essential for companies to manage their profits and losses carefully, as sustained losses can significantly erode retained earnings and affect the financial stability and growth prospects of the company.

The other options do not accurately reflect the nature of retained earnings in the context of a net loss. If retained earnings were to remain unchanged or increase, it would imply that losses have no effect, which contradicts basic accounting principles. Transferring losses to dividends doesn't apply, as dividends are paid out of profits and not losses.