Stockholders Equity

Owners equity refers to the residual ownership interest in a business after liabilities are subtracted from assets.

For publicly traded corporations, owners equity is called stockholders equity, or shareholders equity.

How to Calculate Equity

The Accounting Equation and Owners Equity:

Assets – Liabilities = Owners Equity

Similar to owners equity, shareholders equity is based on the book value of assets less the book value of liabilities, also called net assets or net worth.

Shareholder equity is also similar to owners equity in that it consists of both owners investments and accumulated earnings. The main difference for publicly traded corporations is that owners contribute equity in the form of paid – in capital, or equity contributed by owners from stock purchases. The stock is listed under shareholder equity as common or preferred stock. Accumulated earnings and distributions of the business are also listed under shareholder equity in the retained earnings account.

Composition of Stockholder Equity on the Balance Sheet

Stockholder Equity (Net Worth)
Common Stock @ Par XXX
Additional Paid-in Capital XXX
Retained Earnings XXX
Total Stockholder Equity XXX

In a sole proprietorship or partnership, an owner could make withdrawals from the equity account, reducing owners equity. These temporary accounts are folded into the permanent equity account at period end, reducing owners equity. The other way to reduce owners equity is from incurring net losses on the income statement. Similarly, in a corporation, shareholder equity can be reduced through capital distributions in the form of dividend payments, and from incurring accumulated net losses, both of which reduce retained earnings.

Because the two main classifications of shareholders equity are paid in capital from owners (stockholders) and retained earnings, there are also essentially two ways to increase shareholders equity similar to owners equity: capital contributions and earning profits (see footnote 1).

Owners Equity Examples

Owners Equity

Shareholders Equity

A corporation can increase shareholders equity by issuing stock. The stock purchases are listed under shareholders equity as paid-in capital, or equity contributed by owners from the purchase of stock. The stock purchases come from the initial sale of stock to the public, in which the corporation receives cash in return for the stock. The sale of stock on the secondary markets (e.g. NYSE, NASDAQ) does not affect the equity of the corporation since the corporation does not receive anything from secondary transactions.

A corporation sells 25,000 shares of $1 par value common stock for $2 per share cash.

Stockholder Equity and Paid-In Capital

Date Account and Explanation Reference Debits Credits
Jan 1 Cash 100 $50,000
Jan 1 Common Stock @ Par, $1 300 $25,000
Jan 1 Additional Paid-in Capital 305 $25,000

Paid in Capital

Assets (Cash) = Liabilities + Stockholder Equity
$50,000 = $0 + $50,000

The accounting balance sheet now shows:

Cash $50,000
Total Liabilities $0
Stockholders Equity
Common Stock @ Par, $1 $25,000
Additional Paid-In Capital $25,000
Total Stockholders Equity $50,000

The par value of the stock is simply the stated value assigned to the stock by the corporation. The par value has no relation to the market value of the stock. Stocks are generally not offered below par since most state laws prevent it. The par value ensures investors that the stock will not be offered at a lower price on a future date. Some stocks do not have a par or stated value and are listed on the balance sheet at the amount realized when the stock was initially sold. The additional paid-in capital account in excess of the par value shows any amount paid over the par value of the stock.

Shareholder Equity and Retained Earnings

Shareholder equity is also increased when a corporation increases net profits on the income statement. Sunny earned a profit of $15,283 the first year in business. Similar to the example in the owners equity section, Sunny would have retained earnings of $15,283 after the company’s first year in business, but in this case listed under stockhoders equity.

Stockholder Equity
Common Stock @ Par, $1 $25,000
Additional Paid-In Capital $25,000
Retained Earnings $15,283
Total Stockholder Equity $65,283

Statement of Stockholders Equity

In addition to the income statement, the balance sheet, and the statement of cash flows, GAAP requires that an entity report changes in retained earnings and any additional changes in equity accounts. An expanded statement of changes in stockholders equity is widely used to comply with this requirement, including changes in comprehensive income (footnote 1).

The statement of stockholders equity shows all the changes that occurred in the equity section from the beginning to the end of the reporting period. The ending balance of the statement of stockholders equity reconciles to the accounting balance sheet shareholders equity section. For companies with comprehensive income, the statement of stockholders equity shows any comprehensive income not reported on the income statement.

Statement of Stockholders Equity Example

For example, the following statement of stockholders equity shows the activity for 2010 for Sunny Sunglasses Shop. Since Sunny started his business on January 1, 2010, the beginning balance is zero. The ending balance is the total activity in both contributed capital and the retained earnings accounts:

Sunny Sunglasses Shop
Statement of Stockholders Equity
December 31, 2010
Common Stock Additional Paid-in Capital Retained Earnings Treasury Stock Total Stockholders Equity
Balances, January 1, 2010
Issued 25,000 Common Stock @ Par, $1 $25,000 $25,000
Additional Paid-in Capital in Excess of Par, $1, 25,000 C.S. $25,000 $25,000
Net earnings $15,283 $15,283
Balances December 31, 2010 $25,000 $25,000 $15,283 $65,283

Footnote 1: What is Comprehensive Income?

More recently, FASB issued FAS 130, which established a third component of equity: comprehensive income. FASB became concerned that unrealized gains and losses from economic events that escaped reporting on the income statement, and therefore retained earnings and equity, did not give the financial statement user the complete, comprehensive picture of equity changes in the business.

FASB now requires that such transactions be reported either separately or in combination with the income statement, and in the equity section of the balance sheet. Comprehensive income includes items like foreign currency adjustments, unrealized changes in available-for-sale securities, changes in derivative instruments, and pension liability adjustments. However, many entities outside of larger corporations will have only minor or no comprehensive income to report.

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  2 Responses to “Stockholders Equity”

  1. Hi Tina!

    There are several reasons why a company buys back its own shares. Over the past few years low interest rates allow companies to borrow money at low cost and buy their own shares to increase earnings per share. There are often good reasons (returning capital to shareholders) and not so good reasons (insider bonuses from increased earnings per share and selling stock at increased share prices) to buy back shares discussed here.

    Kenneth Meunier

  2. Why does a company buy back its own shares?

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