Accounting and Reporting Changes in Owners’ Equity - dummies

Accounting and Reporting Changes in Owners’ Equity

By John A. Tracy

The three primary financial statements (income statement, balance sheet, and cash flow statement) accountants use — as important as they are — can’t convey all the information that the lenders and investors of a business want to know and are entitled to know, so a business should include additional information.

One prime example is the statement of changes in owners’ equity. This statement supplements the information disclosed in the owners’ equity section of the balance sheet. The term statement is overkill, if you ask me. It’s more of a schedule or summary of the activities during the year that changed the company’s owners’ equity accounts.

The example presents the statement of changes in stockholders’ equity for a product company. The company in the example had a minimum of transactions during the year involving its two owners’ equity accounts. The business operates as a corporation, so its invested capital account is labeled capital stock.

You could argue that the statement is not really needed because the reader could pick up the same information from the company’s primary financial statements. However, presenting the statement of changes in stockholders’ equity is very convenient for the financial report reader.

changes in equity

Larger businesses generally have more complicated ownership structures than smaller and medium-size companies. Larger businesses are most often organized as corporations. Corporations can issue more than one class of stock shares, and many do. One class may have preferences over the other class and thus is called preferred stock.

A corporation may have both voting and nonvoting stock shares. Also, business corporations, believe it or not, can engage in cannibalization: They buy their own stock shares. A corporation may not cancel the shares it has purchased. Shares of itself that are held by the business are called treasury stock.

The main point is that many businesses, especially larger public companies, engage in a broad range of activities during the year involving changes in their owners’ equity components. These owners’ equity activities tend to get lost from view in a comparative balance sheet and in the statement of cash flows. Yet the activities can be very important. Therefore, the business prepares a separate statement of changes in stockholders’ equity covering the same periods as its income statements. Some of these are monsters and have upwards of ten columns for the elements of stockholders’ equity.

The statement of changes in stockholders’ equity is where you find certain technical gains and losses that increase or decrease owners’ equity but that are not reported in the income statement. You have to read this summary of changes in the owners’ equity accounts to find out whether the business had any such gains or losses. Look in a column headed comprehensive income for these gains and losses, which are very technical.

The general format of the statement of changes in stockholders’ equity includes columns for each class of stock, treasury stock, retained earnings, and the comprehensive income element of owners’ equity. Professional stock analysts have to pore over these statements. Average financial report readers probably quickly turn the page when they see this statement, but it’s worth a quick glance if nothing else.