What is the Purpose of the Statement of Owner’s Equity

The purpose of the statement of owner’s equity is to reflect the changes in owners contributions and withdrawals, movements in reserves and the business’s profit or loss over time. The statement reflects realised gains and losses of the business and their unrealised ones too, more about these another time.

What is the Statement’s Purpose?

Nowadays, this statement is better referred to as the Statement of Changes in Owner’s Equity, a more accurate description of its disclosing information.

Because this statement is the nexus between the statement of financial performance and the statement of financial position, people often miss it in their business analysis.

How is it the nexus? The statement of financial position provides a snapshot of owners equity at a point in time but doesn’t provide a lot of detail in what is driving those changes in equity. Of course, a big part of this change is the profit (or loss) generated from the firm’s activities throughout the year. This profit information comes from the statement of financial performance.

But what users of financial reports also find helpful to know is what changes are taking place within the business’ equity accounts. In particular, where we are dealing with non-cash items that the statement of cash flow doesn’t pick up. Or non-operating activities, which the statement of financial performance doesn’t show — for example, movements between capital or reserve accounts.

Worked Statement Example of Owner’s Equity

Table 1 below provides a good example of a simplified statement. Working through this statement of owner’s equity changes for ABC Ltd for the year ending 31 March 20XY will help us understand its purpose and see some of the common transactions it discloses.

An example of a statement of owner's equity, helping explain its purpose and importance to stakeholders.

You can see the statement has an opening balance, 1 April 20XX, and then reflects equity changes taking place through the year. Let’s have a brief look at each line item before taking this statement and reviewing the transactions that it reflects.

Profit for Year

This figure comes from the statement of financial performance and, of course, reflects the profit, or loss, from the business’ operations over the year. In this case, we are picking up the profit after interest and taxes.

This figure moves through the accounts in the retained earnings. You can see the addition of $1,270,000 to the opening retained earnings figure. Like all the equity flows we are discussing here, the ending balances, which are a snap-shot at a point-in-time, end up in the statement of financial position.

Revaluation Surplus

Revaluation reserves are a common cause of movements within a firm’s equity. In this case, ABC had a net movement in its revaluation reserve for several properties it owns. We aren’t going to go into asset revaluations here; another article will cover this.

The changes Table 1 above reflects are the result of the following end-of-year journal entry ABC’s accounting team recorded. This was due to permanent material movements in estimated valuations of properties as part of its internal review process:

DateAccount NameDebitCredit
31 MarchLand$300,000
Revaluation Reserve – Land$300,000
Journal Entry 1

The statement of financial position picks up the debit, increasing the carrying value of the land account.

Dividends Payable

Dividends are a normal part of the private enterprise process as a reward to owners for the economic resources of capital they put at risk for potential gain. The year-ending 31 March 20XY was a good year for ABC, so the dividends declared and paid to shareholders (owners) were $600,000. The journal entry to record the commitment made when the dividends were declared is:

DateAccount NameDebitCredit
31 MarchRetained Earnings$600,000
Dividends Payable$600,000
Journal Entry 2

When the payment of the dividends is made in 20YY, ABC will make the following journal entry. This entry doesn’t get reflected in the statement of owner’s equity because the capital impacts have already been accounted for. Journal entry 3 below picks up the changes in reducing liabilities “Dividends Payable” and reducing bank funds.

DateAccount NameDebitCredit
31 MarchDividends Payable$600,000
Bank$600,000
Journal Entry 3

Issue of Shares and Share Premium

The last equity transaction disclosed in the statement is for the shares issued during the year and the associated share premium. ABC Ltd raised additional capital by bringing on several new shareholders. They issued 500,000 shares at $1.20 each. These ordinary shares have a par value of $1.00, generating a premium of $0.20 per share. The new shareholders paid in full in cash.

To recognise the funds the new shareholders sent to ABC, we would make the following entry, increasing funds at the bank and bringing to account a liability in shares that are owed to be allocated:

DateAccount NameDebitCredit
31 JanuaryBank$600,000
Share Allotment$600,000
Journal Entry 4

Once funds had been received and share certificates etc. prepared, the shares would be allocated, eliminating the allocation liability, increasing ABC share capital and bringing to account the share premium of $100,000 (i.e. 500,000 ordinary shares at a $0.20 premium = $100,000):

DateAccount NameDebitCredit
31 JanuaryShare Allotment$600,000
Share Capital$500,000
Share Premium$100,000
Journal Entry 5

Conclusion

We hope this has helped you understand the types of transactions the statement of changes in owner’s equity reflects and its purpose and importance to particular stakeholder groups.

We also touched on the revaluation of assets, the declaring of dividends and the raising of share capital. We’ll be coming back to those essential topics in future articles. If these are of interest to you, please use the search function on the site, as I’ll probably forget to come back and link them from here.

Recent Posts