Purpose of the Statement of Owner's Equity helps in disclosing what movements in capital and reserve accounts are taking place.

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 not only reflects realised gains and losses of the business but also their unrealised ones too, more about these another time.

What is the Statement’s Purpose?

Now days this statement is better referred to as the Statement of Changes in Owner’s Equity; a more accurate description of what information it is disclosing.

Because this statement is the nexus between the statement of financial performance and statement of financial position, it is often neglected in people’s analysis of a business.

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

But what users of financial reports also find useful 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 pickup and non-operating activities, and therefore 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 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 to understand it’s 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. Lets have a brief look at each line item before taking this statement and reviewing the transactions that it reflects.

Profit for Year

This figure is picked up 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 is being carried through the accounts in the retained earnings account. You can see it is added to the opening retaining figure of $1,270,000. 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 it’s revaluation of 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 material permanent 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 and so the dividends declared and paid to shareholders (owners) was $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 dividends are paid in the 20YY year the following journal entry would be made. This entry of course 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 a reduction in liabilities “Dividends Payable” and reduction in 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 that for the shares issued during the year and the associated share premium. ABC Ltd raised additional capital by bringing on a number of new shareholders. They issued 500,000 shares at $1.20 each. These ordinary shares have a par value of $1.00, so this generated 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 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 (ie 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 your understanding of the types of transactions the statement of changes in owner’s equity reflects and its purpose and importance to certain 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 important 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.

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