Components of Shareholders’ Equity

Shareholders’ equity represents the owners’ residual claim on a business entity’s assets after deducting its liabilities. This includes all funds that were directly invested in an entity by its owners, earnings that have been reinvested over time, and unrealized gains and losses that are not yet recognized in the entity’s income statement.

Components of Shareholders’ Equity

There are six components of shareholders’ equity. These are:

• capital contributed by owners (or common stock, or issued capital): this is the amount of capital that was contributed to the entity by its owners. For each class of common shares issued, the entity must disclose the number of shares authorized, issued, and outstanding;
• preferred shares: these shares have rights concerning the receipt of dividends or assets upon liquidation of a business entity, which takes precedence over the rights of common shareholders;
• treasury shares: these shares are also referred to as treasury stock. They are shares in a business entity that it has repurchased. Repurchase of shares reduces shareholders’ equity by the amount invested in the acquisition of the shares. In addition, the repurchase of shares reduces the number of outstanding shares;
• retained earnings: this refers to the aggregate amount of earnings that are recognized in the income statements of a business entity and have not been paid out as dividends;
• accumulated other comprehensive income (or other reserves): this includes other comprehensive income which has not been recognized as part of net income and reflected in retained earnings; and
• Noncontrolling interest (or minority interest): this represents minority shareholders’ interests in subsidiaries that have been consolidated by the parent company but are not wholly owned by it.

The statement of changes in equity provides information on the increments or decrements in the equity of a business entity over a specified period of time. Under IFRS, the following information must be included:

• total comprehensive income;
• the effects of any accounting changes which were retrospectively applied to previous periods;
• capital transactions and distributions with shareholders; and
• reconciliation of the carrying amounts of each equity component.

Question 1

Which of the following is least likely a component of shareholders’ equity?

1. Taxes payable.
2. Treasury shares.
3. Retained earnings.

Solution

The correct answer is A.

Taxes payable is a liability and not a component of shareholders’ equity.

Options B and C give answers which are both components of shareholders’ equity.

Question 2

Preferred shares are classified on the balance sheet as:

1. Debt.
2. Equity.
3. Debt or equity.

Solution

The correct answer is C.

Preferred shares could be classified as debt or equity depending on the agreed-upon terms. If the shares are perpetual, they should be classified as equity. And if the shares are redeemable at a specified date or a predetermined event, they should be reported as a liability.