Contents
Introduction
The course about the statement of changes in owner’s equity (“statement” hereinafter for the purpose of having the materials easier to read) is focusing on helping you to present your company’s equity in the detail required.
As always, we begin with explaining the statement itself, the meaning of it and why it’s used. We then move onto the framework of it and slowly piece by piece try to help you in building it up. We focus on the most common changes in the equity accounts and with the use of our template you can easily alongside see how they are to be presented. Just to add that bit of extra incentive, we also explain why the statement is of importance.
The course itself is structured with the aim to have it easily follow able and understandable with examples to illustrate where possible. There will be just simple words and everything written in “down to earth” style for an easy and quick understanding.
So let’s kick off!
Downloads
Statement of changes in owners equity (.pdf)
Statement of changes in owners equity template (.xls) | (.xlsx) | (.ods) | (.pdf)
What exactly is the statement of changes in owner’s equity?
The statement of changes in owner’s equity is part of the four main statements included within the annual report. It reflects, as the name says, changes for equity accounts for current and prior period as well as beginning and ending balances for the accounts.
The statement on its own tells the story of how the capital invested into the company by the owners has been used over the period. It gives an overview of the capital position, what other reserves compose of and how company uses the retained earnings (i.e. if it pays out dividends etc.).
Something to note however that is the statement isn’t on its own in the accounting as such and is merely a reflection of what’s already disclosed in less detail on the balance sheet and income statement.
We’ll move onto how to compose one and explain a bit each of those accounts.
Composing the statement
Essentially there are two things one must remember when it comes to composing the statement.
Firstly, always remember that it’s a schedule that reflects changes over the period. Now, as you may recall, one of the things to watch out when preparing the annual report was displaying prior period figures alongside current ones. This does indeed apply to the statement of changes in owner’s equity just as well. And something that in our view relates is the obvious fact that all figures must match with applicable other statements (i.e. beginning and ending balances with figures on the balance sheet, profit or loss for the period with income statement etc.)
Secondly note that there are never “other movements” without any further clarification presented on the statement. Either they are clearly disclosed in the notes to enlighten the readers about changes in equity accounts or the name of the change is very clear already from the statement. As a general rule all readers are curious about any changes done to the equity accounts as it’s what reflects company’s strength. Its own capital is what keeps it strong and viable. We’ll come to the importance of the statement later in our course.
So what you want to do is start from the beginning of the prior period with the balances at that date and continue adding the effects of the changes.
Your intermediate milestone is the beginning of the current period, which is a sum of the balances and added changes. And from this you start it again with lining up all changes to the accounts only to reach to the end balances which are also the same as on the balance sheet itself.
Now remember the key word “detail” and start with displaying movements in all your company’s equity accounts one by one. Keep it detailed, explained further in notes if need be and informative rather than secretive.
Components of the statement
The equity accounts you disclose movements for are exactly the same as the ones on the balance sheet – share capital, share premium, other reserves and retained earnings in our example. The changes themselves we’ll cover for each of those components in this section.
Please note that the headings shown for columns on this picture are the same for all the other images shown.
In essence a share capital is the very initial capital paid into a company when it’s incorporated. What continues really are further investments made by the owners to support business. Please note however that legislation may set minimum requirements for capital and as such, if things go not as planned as in the company earns losses, the law may have certain ratio requirements in comparison to equity and share capital.
A transaction that’s most common when it comes to share capital is indeed payments made into it. Yes, decreasing one is also an option, but drifts away from the goal of our course. So as such, we’ll cover the payments made into.
Generally speaking, whenever owners make payments into equity, it’s formalized through releasing new shares with their nominal cost (something that’s set for a share already in the articles of association). One thing is the nominal cost though; the other thing is the premium paid that exceeds the nominal value but which still is decided to be paid into the capital (hence the share capital).
Either way, as in our example, for the purpose of our course, say that the nominal paid was 1,000 and the premium 7,000. The accounting entry in such a case would be as follows:
Db Cash and cash equivalents 8,000
Cr Share capital 1,000
Cr Share premium 7,000
In a similar way you’d show it on your statement of changes in owner’s equity. On the very same line you show proceeds from the issued shares under the share capital and share premium column.
Other reserves
Other reserves is something that’s there as a part of equity but may also not be there. It’s really dependent on the company and its business.
Anyhow, in case your company does have it, there must a reason for it. There are many things that can be disclosed a part of other reserves – owner’s loans, bonds given etc. but more down to earth things most probably would be asset revaluations.
Now in case you measure your land and buildings at fair value and not as cost less depreciation, something you’re bound to do is measure them annually and recognize all loss or gain from it. Should the new value exceed the old one, you get gain and vice versa.
As in our example there’s gain from the transaction, the entry would be as follows:
Db Land / Building
Cr Other reserves
A reason to recognize extraordinary losses or gains as a part of other reserves is simple – yes, if it’s gain, it’s nice to have it in the profit for the year, but if it’s loss? You would not want such non-business related transactions to affect your results for the year now wouldn’t you?
Retained earnings
Your company earns profits which accumulate over time into something called retained earnings.
Effectively what you do is add your end result from the income statement into the beginning balance and that’s your new retained earnings. If no other movements happen over the period within the balance, it’s what you carry forward. There isn’t an accounting entry for that, it’s just where the profit or loss is grouped under equity and it changes naturally whenever you book for an expense or income on the income statement.
Now in case you do decide to pay our dividends, it’s something that normally comes from retained earnings and that’s a decrease to the balance. The accounting entry in such a case would be as follows:
Db Retained earnings
Cr Payable to owners
Once you make the payment, you use the same logic as with paying to your suppliers:
Db Payable to owners
Cr Cash and cash equivalents
Please note that paying dividends is a transaction on its own and as such it’s not simply taken off from current year profits. No, it’s disclosed as a separate change and what’s more, it’s advisable to show to which year’s profit the dividends relate to (as in our template its stated “Dividends relating to 2009” for an example). Why? Simply to show which year’s earnings we’re taking out.
Importance of the statement
The statement of changes in owner’s equity carries great importance which is imminent from its name really if you think about it. There’s the owners and what they’ve put into the company. What the statement really shows is the movements within the equity accounts over the period. Yes, even if the movement happened within the period and even if it carries no effect on balances at the reporting period date, it’s still important to disclose those statements. Why?
Reason being very simple really – equity shows the strength of a company. But not only strength, it’s the efficiency the business is financed with just as well.
Strength is pretty obvious if you think about it. In case of financial difficulties and adverse situations a company with a strong capital position is able to survive more than one with a weaker standing in terms of existing equity. “How so?” you may ask now.
The aim of a company is normally to earn profits which in return increase the equity. So as you may have guessed, bigger equity means stronger position. A stronger position in a sense that if things go bad and your company earns losses for some reason, earned profits in prior years can in turn now swallow the losses and not hurt your equity. If the retained earnings aren’t all that big and your company is making losses, there’s going to be a point where there amount goes into negative. And this starts to really hurt your equity in a sense that you may not meet required minimum equity amount anymore. If you think about it, equity is a sum of share capital, share premium and retained earnings. If first two can never be negative, the last one can. In a situation it does go into red, it will decrease the sum of share capital and premium. Up to the point the gap falls below the required minimum, your company is forced by law to increase the reserves or file for bankruptcy.
What the statement of changes in owner’s equity does is showing all movements the owners have done over the period into something so vital for a company.
Efficiency is something that’s in a way more related to running the business usually, but there’s also something called efficient financing. As a general rule, a company should be run more on third party financing than its own finances. And we do not necessarily mean loans, but supplier payables etc.
Generally speaking, your liabilities should exceed the equity. Liabilities are in fact third party financing received to acquire assets useful for business. The longer payment terms, the better financing conditions and the more significant balances. Something to note obviously is the seasonality obviously. If a company acquires let’s say raw materials only once a year, it’s liabilities may be swollen significantly at that point giving an adverse ratio from average, however the point remains.
The statement of changes in owner’s equity is also an efficiency reflection. An equity that’s exceeding liabilities and is mostly comprising of retained earnings is a sign the company is either preparing for a huge investment, spreading it’s business or considerably over capitalized. The latter of which can be solved with paying out dividends. Something the owners rightfully deserve and something that keeps the company healthy.
Presentation
The statement of changes in owner’s equity is presented in a form of a table for current and prior periods. That’s something we covered already above.
Just as balance sheet and income statement it too can include references to notes and as such, please keep in mind that all significant changes need to be explained and given detailed information about in the referred notes. When the balance sheet and income statement have variations when it comes to presentation opportunities, the statement of changes in owner’s equity really has none. Only thing to possibly consider is the headings for movement types like in our template – “Comprehensive income”, “Transactions with owners” etc. That’s about all there is really.
Hopefully this course gave you an idea of what the statement of changes in owner’s equity essentially is and how it works. What we did was a short introduction to different types of equity accounts and general movements there may be for those accounts over the period. Something to also note is the way they’re disclosed on the statement – something our template can help you further with. Please note however that this statement isn’t a statement on its own but a composition of balance sheet and essentially income statement. As such, we strongly recommend you also take a look at our balance sheet and income statement course.