Wednesday, 13 January 2016

What is in the detail of the equity section of the balance sheet?

Share capital and the share premium account together relates to the amount that investors actually have invested into the business.

Retained earnings relate to the total amount of profit that the company has made ever since it started trading and that has not yet been given back to the shareholders.  This is the profit that has been reinvested back into the business on behalf of the shareholders.

Other equity reserves relate to amounts owed to the shareholders, but that cannot be classified as profit or investment - an example of another reserve might be a revaluation reserve.

The balance sheet of a company may be titled "Consolidated statement of financial position".  This means that the balance sheet is the combined balance sheets of all the different companies through which it conducts its business.  It is quite possible that it does not own 100% of all of its subsidiary companies.  If another party owns a very small part of the business, for example, 2% of one of the subsidiaries, then this share will be shown under equity as non-controlling or minority interests.

What is the difference between share capital and share premium?

The share capital is the nominal value of all investments in the business by shareholders.

The sale of additional shares at a premium to the original or nominal value at which the initial shares were issued would be accounted for as shown:

Nominal value $450 per share
Additional shares sold at $500 per share.
For each share sold for $500 each, $50 would be accounted for as share premium and the remaining $450 would be accounted for as share capital.

Share premium is the premium over and above the nominal value of the share.  

What is a revaluation reserve?

Company A bought a building for $1 million and that building was now worth $2 million.  The company might decide to increase the property, plant and equipment on the balance sheet by $1 million.

In order for the balance sheet to continue to balance, the equity section of the balance sheet must, therefore, also increase by $1 million.

Company A cannot increase the called up share capital or share premium accounts, as there has been no additional investment in the company.

It cannot increase the retained earnings figure because it has not made a profit on the building (Company A can recognise a profit on the building only when it actually sells the asset).

It may, therefore, choose to set up a revaluation reserve to account for the increase in the value of the building.  This would appear in the equity section as other reserves.

In effect, an increase in the value of the building is merely an increase in the amount that Company A now owes to the shareholders.

No comments: