Key Takeaways
- The Statement of Changes in Equity is a financial statement that describes in detail the activities that affect the net worth of the owners of a company over the years the latter operated.
- The layout of the statement of changes in equity depends on the legal form or structure of the company. This means that the statement of changes in equity of a corporation may look different than those of a sole proprietorship or a partnership.
Introduction to the Statement of Changes in Equity
The Statement of Changes in Equity is a financial statement that shows in detail the changes in equity over a period of time.
The Statement of Changes in Equity is an important financial statement that you’ll need to prepare if you want to see in detail the activities that cause the movements in each component of equity over the years that your company operated.
What is equity? Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Equity can also be referred to as net assets because it represents the amount claimable by the business owners on its assets after deducting the liabilities. It is basically the rights of the owners to the assets of the business.
The equity elements or components of a company may depend on its legal form or how it was organized. The 3 main legal forms of a company are sole proprietorship, partnership and corporation.
A sole proprietorship is a legal form of business that is owned by a person called the proprietor. The two main components of the owner’s equity in a sole proprietorship are as follows:
- Owner’s Capital – includes total investments or contribution by the proprietor to the business and the accumulated profits of the business since its inception. However, the accumulated profits can be presented in a different account to separate them from owner investments.
- Owner’s Drawing – represents the withdrawal of business resources by the proprietor to convert them to personal use. This is deducted from the owner’s capital at the end of the period to get the net amount of owner’s capital.
A partnership is a legal form of business that is owned by two or more individuals called partners. The partners’ equity has the same components as a proprietorship. The only difference is that each partner has their own capital and drawing accounts.
- Partner’s Capital – includes total investments or contributions by the partner to the business and their share of the accumulated profits of the business. The accumulated profits can also be presented in a separate account.
- Partner’s Drawing – represents the withdrawal of business resources by the partner to convert to personal use. This is deducted from the partner’s capital at the end of the period to get the net amount of the partner’s capital.
A corporation is a legal form of business that is owned by shareholders. The shareholders’ equity is composed of the following:
- Share Capital – also called Capital Stock, the share capital represents the investments made by the shareholders of a corporation. It includes both ordinary (common) shares and preference (preferred) shares.
- Share Premium – also called Additional Paid-In Capital, share premium is the additional amount paid by the shareholders in excess of the par or stated value or stated value of the shares issued to them.
- Retained Earnings – also called Accumulated Profits, retained earnings represents the sum of all cumulative net income earned by the corporation since its inception that is not distributed as dividends to shareholders.
- Treasury Shares – also called Treasury Stock, treasury shares are the corporation’s own shares that have been previously issued and subsequently reacquired or repurchased from its shareholders.
Presentation of Statement of Changes in Equity
The layout of the statement of changes in equity may depend on the legal structure of your business. However, regardless of the form of your business, this financial statement should include the following information:
- Total comprehensive income for the period that includes profit or loss and other comprehensive income.
- The effects in equity of retrospective application of changes in accounting policies and correction of errors.
- Issuance of shares or additional investments by the business owner.
- Dividends or distributions to owners.
Below are some illustrative examples of how the presentation of statement of changes in equity would differ on a sole proprietorship, a partnership or a corporation.
Statement of Changes in Owner’s Equity
The statement of changes in equity of a sole proprietorship is the easiest to be prepared since it is more simple and involves less components compared to a partnership and a corporation.
The statement of changes in owner’s equity above presents in detail the changes that affected the components of the sole proprietorship’s equity. It provides the following information:
- The opening or beginning balance of the owner’s capital account during the period, which is the ending balance from the previous period.
- Any additional investments or capital contributions by the owner during the period. These items are added to the opening balance of the owner’s capital account.
- Net income or net loss during the period. Net income is added to the opening balance of the owner’s capital account while net loss is deducted.
- Any capital distributions or owner withdrawal of resources during the period. These are deducted from the opening balance of the owner’s capital account.
- The closing or ending balance of the owner’s capital account at the end of period. Keep in mind that the ending balance becomes the beginning balance of the next period.
Statement of Changes in Partners’ Equity
If your company is a partnership, here’s an example of how the statement of changes in equity could be presented.
If you’ll notice, the statement of changes in partners’ equity has the same format and components as the statement of changes in owner’s equity of a sole proprietorship. The only noticeable difference is that the statement includes separate columns for each partner to reflect their equity shares.
The net income or net loss during the period is shared by each partner depending on their agreement for profit or loss sharing. Typically, the sharing would be based on capital contributions of each partner.
Statement of Changes in Shareholders’ Equity
The statement of changes in shareholders’ equity of a corporation involves more components or accounts compared to those of sole proprietorships and partnerships. Here’s an example of a statement of changes in shareholders’ equity.
In the above example, separate columns are assigned for each component of equity. It begins with the opening balance of each component and ends with the closing balance at the end of the period, after adjustments are applied for transactions that affect each component during the period.
You may try to look for some actual statement of changes in shareholders’ equity of some large corporations with complex transactions to get an idea of how they present information related to the changes on each equity component. A consolidated statement of changes in shareholders’ equity is usually prepared by corporations with parent-subsidiary relationships for the purpose of presenting them as a single economic entity.
While the examples above contain distinct titles for the statement of changes in equity of a sole proprietorship, a partnership and a corporation, many companies generally use Statement of Changes in Equity as the title of the financial statement. The International Accounting Standards (IAS 1) allows the use of titles other than those mentioned by the standard for financial statements such as the statement of changes in equity.
Review Questions
- What is the statement of changes in equity and how useful is the information it provides?
- What is the main difference in the presentation of information between the statement of changes in equity of a sole proprietorship and a partnership?
- What are the components of the shareholders’ equity?
- What are the reconciling items between the opening and closing balance of equity in the statement of changes in equity.
- What does equity represent?
