Introduction to Finance/Financial Statements/Statement of Shareholders’ Equity

Financial Statements

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Statement of Shareholders’ Equity

Introduction to the Statement of Shareholders’ Equity

The statement of shareholders’ equity is a financial report that is associated with stockholdings and investments into the company; it shows the difference in the company's retained earnings for the start of the period and retained earnings for the end of the period.

The statement of shareholders’ equity, also referred to as the statement of stockholders’ equity, is a financial report that is associated with stockholdings and investments into a company. Generally accepted accounting principles (GAAP) requires the composition of the statement of shareholders’ equity in addition to the income statement, balance sheet, and statement of cash flows. Depending on the preferences of the preparer, the statement of shareholders’ equity may appear as its own document or as an inclusion on the balance sheet or income statement.

The statement of shareholders' equity represents changes in shareholders' equity from the beginning to the end of a period. The change in equity from the beginning to the end of a period is the result of netting all the components that make up equity: capital stock, treasury stock, retained earnings, and certain gains and losses. Retained earnings represents the undistributed portion of an organization’s net income over its entire history. Therefore, each year that a company reports net income but does not pay that out entirely as dividend, retained earnings increases. A dividend is a distribution of a corporation's earnings in the form of cash, stock, or property to the stockholders as voted on by the board of directors. While income, net of dividends declared, increases retained earnings, net losses decrease retained earnings. To put it simply, a company's retained earnings represents the income left over after accounting for all expenses and dividends declared. Companies typically reinvest retained earnings in the company to facilitate additional growth.

Thus, the statement of shareholders' equity allows shareholders to see how their investments are performing. This information is also useful for the company itself to make decisions regarding future issuance of stock shares.

Relationship of Statement of Shareholders' Equity to Other Financial Statements

The statement of shareholders' equity relates to the other financial reports through the accounting equation; the equation for the statement of shareholders' equity is the end of period retained earnings equal to the beginning of period retained earnings minus end of period dividends paid out plus end of period net profit.
The statement of shareholders' equity relates to the other financial reports through the accounting equation. The shareholders' equity equation and the accounting equation are similar. The accounting equation (Assets=Liabilities+Shareholders’ Equity\text{Assets}=\text{Liabilities}+\text{Shareholders' Equity}) reveals the value of a company's assets and the distribution of claims to those assets. If the company were to be immediately liquidated, the equation shows how much of the assets would go to creditors and how much would go to shareholders. The statement of shareholders' equity equation is nearly as simple as the accounting equation.
End of Period Retained Earnings=Beginning of Period Retained Earnings−Dividends+Net Profit{\text{End of Period Retained Earnings}=\text{Beginning of Period Retained Earnings}-\text{Dividends}+\text{Net Profit}}
For the equation to yield accurate results, it is essential that the retained earnings come from two consecutive periods. The company's balance sheet records the retained earnings and the company’s dividend expense figure from the income statement that are paid out to shareholders. The statement of shareholders' equity is useful for identifying the residual claim owners have on the company from their equity. For example, when examining the statement of shareholders' equity over multiple periods, an investor can determine whether or not the residual claim is growing and the rate at which it is growing. For example, an accountant at Jake's Home Decor Shop wishes to create a statement of shareholders' equity for year 2. The accountant reviews Jake's Home Decor Shop's year 1 balance sheet and identifies the retained earnings for the end of the period for year 1 as $2,225,000. Next, the accountant uses Jake's Home Decor Shop's year 2 balance sheet to identify its net profit for the end of the period for year 2 as $500,000. Next the accountant locates the resolution of the board of directors to declare a dividend of $345,000. The accountant has all of the relevant information required to calculate the end of period retained earnings for Jake's Home Decor Shop. The accountant applies the statement of shareholders' equity equation.
End of Period Retained Earnings=$2,225,000−$345,000+$500,000{\text{End of Period Retained Earnings}}=\$2{,}225{,}000-\$345{,}000+\$500{,}000
Lastly, the accountant records $2,380,000 as the retained earnings for the end of the period for year 2.
The statement of shareholders' equity shows how change in shareholders' equity may be calculated using the shareholders' equity equation.
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