6 Statement of Changes in Equity
Linking the Income Statement to the Statement of Financial Position
Jacqueline Gagnon
What is equity? You already know that equity is a section on the Statement of Financial Position and that equity belongs to shareholders. Remember this equation?
Assets – Liabilities = Equity
This chapter is all about equity and the statement that tells us about what happened in equity over a period of time, namely the Statement of Changes in Equity.
The main financial statement user is shareholders – owners of the company – and equity is super important to them. Afterall, equity is what they own in the company. For example, shareholders may want to know if the company sold or repurchased shares, what their ownership interest is, and how much they have earned on the money they’ve paid into the company.
Shareholders contribute money by purchasing shares and then earn income over time. This brings up an important issue. There are two types of Equity:
- Share Capital:
- cash contributed by owners.
- Retained Earnings:
- equity earned from owner contributions.
In fact, these two categories are so important that the Statement of Changes in Equity is divided into share capital and retained earnings. Now that we know how important this distinction between cash received from shareholders and earnings on these contributions, let’s back up and discuss the Statement of Changes in Equity.
This statement tells the story of each type of equity over a period of time. How does it tell the equity story? It starts with the beginning balance of shares and retained earnings, describes how and why the balance of each equity type changes over the period, and then gives the ending balance. The ending balance of common shares and retained earnings will show up on the Statement of Financial Position in the equity section, so the Statement of Changes in Equity is an important link to bring the financial statements together.
Let’s take a peek. The Statement of Changes in Equity looks like this:
| Common Shares | Retained Earnings | Total | |
|---|---|---|---|
| Balance, beginning | |||
| Net Income | |||
| Dividends Declared | |||
| Issuance of SharesShare Issuance: An economic transaction whereby a company transfers shares in exchange for cash. |
|||
| Repurchase of SharesShare Repurchase: An economic transaction whereby a company buys their own shares off the market (if publicly listed) or from existing shareholders (if publicly listed). |
|||
| Net Change | |||
| Balance, ending |
Notice the title? This is a story-telling statement. We know it tells a story because of the phrase for the year ended. Where else have you seen this phrase? That’s right – on the Income Statement! The first column summarizes all the transactions that happen in equity, then we see common shares, retained earnings, and a total column. Aha – remember the two types of equity: shares and earnings on shares? We have a column for each here: common shares and retained earnings. Lastly, the total column is a simple line total.
Let’s look at the first column. It describes changes to the balances of equity. It’s not surprising that Net Income and Dividends Declared show up here. After all, you learned to calculate ending Retained Earnings in chapter 4. Remember?
So you’ll notice a and in the retained earnings column for these items. That simply means that you will enter net income from the Income Statement under the retained earnings heading as a positive number: you’ll add net income to calculate ending retained earnings. The opposite is true of dividends declared. You will subtract dividends declared to calculate retained earnings, so there’s a in the retained earnings column.
On the other hand, issuance of shares and repurchase of shares change the number and value of common shares outstanding, so you will see a for issuances and for repurchases in the common shares column.
For the purposes of an Introduction to Financial Accounting class, this template incorporates all changes in equity balances. Use it. Memorize the ways that equity changes. And start thinking about motivations for owners and companies to manage equity.
The next two sections look at two columns in the Statement of Changes in Equity: (1) common shares and (2) retained earnings with opportunities to practice preparing this statement. The last section introduces one of the most prominent financial statement ratios: Earnings per Share (EPS)Earnings per Share (EPS):
Gives shareholders feedback on how much value has been created on each common shares during the period. Calculated as income attributable to common shareholders divided by weighted average number of shares outstanding.. Let’s go!