Saturday, 26 December 2009

The Statement of Shareholders' Equity

The statement of shareholders' equity starts with beginning-of-the period equity and ends with end-of-the period equity, thus explaining how the equity changed over the period. 

For purposes of analysis, the change in equity is best explained as follows:

Ending equity = Beginning equity + Comprehensive income - Net payout to shareholders


Beginning equity
+Comprehensive income
- Net payout
=Ending equity

This is referred to as the STOCKS AND FLOWS EQUATION for equity because it explains how stocks of equity (at the beginning and end of the period) changed with flows of equity during the period. 

Owners' equity increases from value added in business activities (comprehensive income) and decreases if there is a net payout to owners. 

Net payout is amounts paid to shareholders less amounts received from share issues.  As cash can be paid out in dividends or share repurchases, net payout is stock repurchases plus dividends minus proceeds from share issues. 


+ Share repurchases
= Total Payout
-Share issues
= Net Payout

Comprehensive income includes net income reported in the income statement pl,us some additional income reported in the equity statement.  The practice of reporting income in the equity statement is known as DIRTY SURPLUS ACCOUNTING, for it does not give a clean income number in the income statement.  The total of dirty surplus income items is called OTHER COMPREHENSIVE INCOME and the total of net income (in the income statement) and other comprehensive income (in the equity statement) is COMPREHENSIVE INCOME:

Comprehensive income = Net Income + Other comprehensive income


Net Income
+ Other comprehensive income
Comprehensive income

A few firms report other comnprehensive income below net income in the income statement and some report it in a separate "Other Comprehensive Income Statement."

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