Statement of changes in equity

A statement of changes in equity and similarly the statement of changes in owner’s equity for a sole trader, statement of changes in partners’ equity for a partnership, statement of changes in shareholders’ equity for a company or statement of changes in taxpayers’ equity for government financial statements is one of the four basic financial statements.

The statement explains the changes in a company’s share capital, accumulated reserves and retained earnings over the reporting period. It breaks down changes in the owners’ interest in the organization, and in the application of retained profit or surplus from one accounting period to the next. Line items typically include profits or losses from operations, dividends paid, issue or redemption of shares, revaluation reserve and any other items charged or credited to accumulated other comprehensive income. It also includes the non-controlling interest attributable to other individuals and organisations.

This primary purpose of Statement of Changes in Equity is to provide details about all the movements in the equity account during an accounting period, which is otherwise not available anywhere else in the financial statements. As such, it helps the shareholders

 and investors in making more informed decisions about their investments. Further, it also allows the analysts and other readers of the financial statements to understand what factors resulted in the change in the equity capital.

The statement is expected under the generally accepted accounting principles and explains the owners’ equity shown on the balance sheet, where:

Owners’ equity = Assets – Liabilities

Requirements of IFRS

IAS 1 requires a business entity to present a separate statement of changes in equity (SOCE) as one of the components of financial statements.

The statement shall show:

• Total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interests
• The effects of retrospective application, when applicable, for each component
• Reconciliations between the carrying amounts at the beginning and the end of the period for each component of equity, separately disclosing:
• Profit or loss
• Each item of other comprehensive income
• Transactions with owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control

Requirements of the GAAP

In the United States this is called a statement of retained earnings and it is required under the Generally Accepted Accounting Principles  whenever comparative balance sheets and income statements are presented. It may appear in the balance sheet, in a combined income statement and changes in retained earnings statement, or as a separate schedule.

Therefore, the statement of retained earnings uses information from the income statement and provides information to the balance sheet.

Retained earnings are part of the balance sheet (another basic financial statement) under “stockholders equity (shareholders’ equity)” and is mostly affected by net income earned during a period of time by the company less any dividends paid to the company’s owners / stockholders. The retained earnings account on the balance sheet is said to represent an “accumulation of earnings” since net profits and losses are added/subtracted from the account from period to period.

Retained Earnings are part of the “Statement of Changes in Equity”. The general equation can be expressed as following:

Ending Retained Earnings = Beginning Retained Earnings − Dividends Paid + Net Income

This equation is necessary to use to find the Profit Before Tax to use in the Cash Flow Statement under Operating Activities when using the indirect method. This is used whenever a comprehensive income statement is not given but only the balance sheet is given.

Closing Balance of Equity = Opening Balance of Equity + Net Income – Dividends +/- Other Changes

• Opening Balance: It represents the value of equity capital at the beginning of the reporting period, which is the same as the prior period’s closing balance of equity.
• Net Income: It represents the net profit or loss reported in the income statement during the period.
• Dividends: Dividends declared during the reporting period should be subtracted from the equity balance as it represents the distribution of wealth among shareholders.

Steps

Step 1. Firstly, determine the value of the equity at the beginning of the reporting period, which is the same as the value at the end of the last reporting period. It is the opening balance of equity.

Step 2. Next, determine the net income or loss booked by the firm.

Step 3. Next, determine the value of the dividend declared by the management for the reporting period.

Step 4. Next, determine all the adjustments for the reporting period, which may include effects of changes in accounting policies, correction of prior period errors, changes in reserve capital as well as share capital.

Step 5. Finally, the closing balance of equity can be derived by adding net income (step 2) to the opening balance of equity (step 1), deducting dividends (step 3), and other adjustments (step 4), as shown below.