Every business starts from some place, and shareholder equity plays a crucial role in the founding process. As such, whatever happens to equity materially affects the running of each business. This article explains the statement of changes in equity and why it is significant to businesses.
What is the statement of changes in equity?
Business operations vary at different periods during an operating year. Usually, the size of a company’s coffers and revenue stream differ at the beginning vs. the end of an operating period. Therefore, there is a need for businesses to capture these changes for the benefit of shareholders who might view the information as relevant. To this end, the statement of changes in equity (PDF) reports the difference between the beginning balance and the closing balance of equity during a particular operating period.
The focus on the balance of the equity account is because during the operating period there are many deductions from equity generated. Some of the deductions made include profits and dividends payable. In a different sense, the statement of changes in equity just gives an account of the specific happenings that affected shareholder equity either positively or negatively. Other names for this statement are the statement of shareholder equity, the statement of owner equity, and the statement of retained earnings.
Since few transactions in the course of a business’s operations affect equity, the statement of changes in equity is usually short. This explains why some companies flat out omit the statement from the body of financial information concerning the business at the end of the operating period. Nonetheless, this item of the balance sheet contains crucial insights about the reserves of equity of the company.
Which transactions constitute the statement?
A financial statement is a collection of transactions that have a common effect. In this sense, the statement of changes in equity collects relevant transactions that affect shareholder equity. Some of the transactions include the profit generated or loss incurred for the particular operating period, payments directed to shareholder dividends, the income and expenditure during the operating period, changes in accounting standards/policies that have a material effect on the computation of profit or loss for the particular period, and any errors rectified.
It is critical to capture all the information because this statement is an important link between the statement of comprehensive income and the financial position of the company. For large corporations, the information in the statement helps to distinguish equity owned by the company’s owners from that owned by the non-controlling interests of the company.
Components of the statement of changes in equity
The change in share capital is a crucial component of the statement. Notably, the item reveals evidence of additional distribution of share capital during the operating period. Usually, accountants subtract redemption of shares from the item for more accuracy of the information. In addition, the company must subtract dividend payments from equity because it implies the taking away of wealth from the company’s owners.
Another key component of the statement is the opening and closing balance of the operating period. The opening balance gives a glimpse into the nature of the previous operating period, while the closing balance depicts what remains at the end of the current accounting period in terms of equity after necessary deductions. Other critical components of the statement of changes in equity include restated balance and any additional gains and losses during the accounting period.