Shareholders’ equity represents the owners’ residual claim on an 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 which 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 in relation to the receipt of dividends or assets upon liquidation of the entity, that takes precedence over the rights of common shareholders.
- Treasury shares: Otherwise referred to as treasury stock, these refer to shares in an entity which have been repurchased by the entity. The repurchase of shares reduces shareholders’ equity by the amount of the acquisition cost and also reduces the number of shares outstanding.
- Retained earnings: This refers to the aggregate amount of earnings that are recognized in an entity’s income statements 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.
- Non-controlling 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 increases or decreases in an entity’s equity 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.
Which of the following is not a component of shareholders’ equity?
A. Treasury shares
B. Taxes payable
C. Retained earnings
The correct answer is B.
Taxes payable is a liability and not a component of shareholders’ equity. Choices A and C give answers which are both components of shareholders’ equity.
Preferred shares are classified on the balance sheet as:
C. Debt or equity.
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’d be classified as equity. If the shares are redeemable at a specified date or a predetermined event, they’d be reported as a liability.
Reading 22 LOS 22f:
Describe the components of shareholders’ equity