Owners’ Equity

Exploring Owners’ Equity | CFA Level I FSA

We’re nearing the end of our journey to understand balance sheets! In this lesson, we’ll discuss the last major component: owners’ equity. So let’s dive in!

What is Owners’ Equity?

Owners’ equity is the residual interest in assets that remains after subtracting an entity’s liabilities. It includes:

Let’s walk through setting up a new company with equity and no debt to learn about these items.

Contributed Capital

At incorporation, a company may decide to authorize 2,500 common shares and issue 2,000 of them to shareholders. If the par value is $1 per share, and the shares are issued at a premium of an additional dollar, the company receives $4,000 in cash. This amount forms the contributed capital under owners’ equity.

Treasury Stock

If the company buys back 200 common shares at $3 each, these shares become treasury stock. The number of outstanding shares drops to 1,800, and the contributed capital is reduced by $600 to $3,400.

Preferred Stock

Suppose the company issues 1,000 shares of preferred stock at $3 each. It receives $3,000 in cash, and $3,000 preferred stock is created under owners’ equity. Preferred stock has certain rights and privileges not conferred by common stock.

Retained Earnings

When the company makes a net income of $1,000 for the year, $400 is paid out to common shareholders as dividends, and the remaining $600 goes to equity as retained earnings.

Accumulated Other Comprehensive Income

For example, if the company buys shares of other companies and classifies them as available-for-sale, and the market value later triples, there’s a $1,200 unrealized gain. This amount is reported as other comprehensive income.

Non-Controlling Interest

Finally, minority interest is the minority shareholders’ pro-rata share of a subsidiary’s net assets, not wholly owned by the parent. For example, if the company acquires a controlling 60% stake in a subsidiary with $4,000 in net assets, $1,600 of minority interest is created.

Statement of Changes in Stockholders’ Equity

This statement summarizes all transactions that increase or decrease equity accounts for a period. Here’s a recap of the changes for our example company:

Adding all these up, we get the ending balance of stockholders’ equity, which should correspond with what is shown in the balance sheet.

And with that, we have completed the 5 major components of the balance sheet. In our next lesson, we’ll wrap up this topic with a discussion on financial analysis using balance sheet data. See you soon!

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