Study: Preparing and Using a Statement of Stockholder Equity
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Slides 1-2 (0m:38s)
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Welcome to Introduction to Accounting Preparing for a User's Perspective
Preparing and Using a Statement of Stockholder Equity
Formula for the Statement of Stockholder Equity
The Statement of Stockholder Equity explains how the investors' equity in a given company changed from the beginning of the year to the end of the year. It is like a financial video that shows what caused the increases and decreases in the Stockholders’ equity accounts from one period to the next. For example, if you wanted to know whether the Stockholders chose to retain the company's Net Income in the business or have it paid out to themselves as a Dividend
Links to an external site., you could find your answer on the Statement of Stockholders equity.
Slide 3 (1m:31s)
Links to an external site.In general, Stockholders’ Equity has two primary accounts: Capital Stock and Retained Earnings.
Although there are other factors that can influence these accounts, the basic equations we will discuss in this course are as follows:
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Beginning Capital Stock |
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Beginning Retained Earnings |
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+ Issuances of Capital Stock |
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+ Net Income (Net Loss) |
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- Repurchases of Capital Stock |
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- Dividends |
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= Ending Capital Stock |
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= Ending Retained Earnings |
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Increases in Capital Stock
Links to an external site. result from investors contributing resources to the business in exchange for ownership shares. Capital Stock decreases when Capital Stock is repurchased from investors by the business.
The beginning Retained Earnings
Links to an external site. balance represents all Net Income from the beginning of time up to the beginning of the period, less all Dividends from the beginning of time up to the beginning of the period. It effectively represents all of the internally generated equity financing that the owners chose to retain in the business. When a business is profitable, its current period Net Income is added to its beginning Retained Earnings balance. When a business is unprofitable, its current period Net Losses are deducted from its beginning Retained Earnings balance. When Dividends are paid out to Stockholders, Retained Earnings decrease.
You should note that the Beginning Capital Stock and Retained Earnings balances come from their ending balances from the prior accounting period because whatever you end with in one accounting period, you will start with the next accounting period.
Slide 4 (0m:59s)
Links to an external site.The Statement of Retained Earnings acts as a bridge between the Income Statement and the Balance Sheet. Accountants refer to this bridging process between the financial statements as "articulation". For example, if a business were to generate $5 of Net Income, it would also show a $5 increase in its net assets (i.e. assets less liabilities) that would be included within the balances on the Balance Sheet. In addition, the company would need to explain how it financed the additional $5 in net assets by showing the $5 on the Income Statement and then showing it increase Retained Earnings on the Statement of Retained Earnings
Links to an external site. and then including the revised ending balance of Retained Earnings (which now includes the new $5 of Net Income) on the Balance Sheet to balance out the $5 increase in net assets.
Assets +$5 = Liabilities $0 + Equity +$5
or
Net Assets $5 (where Net Assets are Assets - Liabilities) = Equity $5
Slide 5 (1m:28s)
Links to an external site.Let’s look at an example of what we can learn by reading just the Statement of Retained Earnings portion of the larger Statement of Stockholder Equity. Please stop the video and review these two statements see if you can recognize which of the two business’ owners chose to keep their Net Income in the business and thereby provide additional internally-generated equity financing
Links to an external site. for their business:
Statement of Retained Earnings Statement of Retained Earnings
For the year ended 12/31/X1 For the year ended 12/31/X1
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Beginning Retained Earnings, 1/1/X1 |
$ 100 |
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Beginning Retained Earnings, 1/1/X1 |
$ 100 |
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+ Net Income |
5,000 |
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+ Net Income |
5,000 |
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- Dividends |
0 |
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- Dividends |
(5,000) |
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= Ending Retained Earnings, 12/31/X1 |
$5,100 |
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= Ending Retained Earnings, 12/31/X1 |
$100 |
Answer: Because no Dividends were paid out to the owners of Business 1, they effectively chose to retain their earnings in the business. By not receiving a Dividend, the owners of Business 1 effectively provided it an additional $5,000 of resources that it will be able to use to generate profits. The nice thing for the Business 1 owners, is that they did not personally have to contribute the $5,000 directly from their own pockets. As a result, Business 1's net assets and its Retained Earnings both increased by $5,000. On the other hand, the owners of Business 2 removed all of their current year profits by receiving a $5,000 dividend, thus reducing the amount of resources the business has available to survive and expand in the future. The owners of many tech start-up companies choose not to receive Dividends for many years while the company is in the start-up and expansion mode. For example, Microsoft was founded in 1975 but it didn't pay out its first Dividend until 2003 long after it dominated the operating system market.
Slides 6-7 (2m:59s)
Links to an external site.What we have here is the Stockholders’ Equity Statements for Super Big Tech Company. This is based off of the Microsoft Stockholders’ Equity Statements but I have changed the numbers and dates to make it more generalized for teaching purposes.
Non-marked up copy of the statement.
Marked-up copy of the statement.
The statements will always be titled indicating the name of the company, the name of the statements, and the period being covered. As you can see it is “For the year ended..”, not “As of…” like a Balance Sheet would be but “For the year ended” indicating changes over a period of time.
The unit of measure is in millions. This means that these numbers are not simple dollars but rather millions of dollars. So this should be $20,434 millions that’s actually over $20 billion. Watch out for that, otherwise you’d undervalue this company, because these are much bigger numbers then they might appear to be at first glance.
It’s comparative. It provides 3 years of information so we can recognize trends over a period of time.
Then we have the Capital Stock section and as you can see, we have the beginning, we have the changes, and we have the end.
We have Retained Earnings but this is a little different because we have another wording here called “deficit”. When the Retained Earnings account goes negative we call it “Retained Deficit” (or Accumulated Deficit). So at the beginning of this period, they were at Retained Deficit position and then over time as it had more earnings they came into a Retained Earnings position so [they went from] Retained Deficit to Retained Earnings over that three-year period.
Then finally we have Accumulated Other Comprehensive Income
Links to an external site. [AOCI]. We will save this account for another class but the basic idea is that these are income [or losses] items [that increased the net assets the] company has [but they] haven’t yet been earned so we cannot put them on the Income Statement. So we’re going to keep it on the Balance Sheet to make sure the Balance Sheet balances but when the income finally becomes earned it will go onto the Income Statement and be pulled off of here [AOCI].
Now take the ending balance for each of these accounts to arrive at the total Stockholders’ Equity at the end of the period.
One interesting thing I hope you noticed in the Common Stock and Paid-in Capital area is that they had a net reduction in the Common Stock issued and repurchased. You see this? They’re repurchasing more than their issuing. Many companies will do this when they have determined that their stock on the stock market is undervalued so they’ll buy it at a low price, hold it for a period of time and then re-issue it, so that is not uncommon.
Down in the Retained Earnings/Deficit section we noticed that it was a Deficit at the end of X1 and X2 but due to the additional Income eating away at that Deficit it brought it from the negative side up into the positive side.
So I hope this was helpful to you in recognizing the key pieces of information on the Statement of Stockholder Equity. I hope you can read it a little bit and understand it. There are some things that we will not talk about in this particular introductory course but you can see the basic flow of the Statement of Stockholder’s Equity.
I hope this has been helpful to you. I wish you all the best on the upcoming quiz.
Aloha.