Equity (or capital) refers to the residual interest of the owners in the assets of a company after all liabilities are settled.
In other words, equity is equal to assets minus liabilities.
Equity = Assets - Liabilities
The term used for equity depends upon the form of business organization.
- For sole proprietorships, it is known as owner's equity.
- For partnerships, it is called partners' equity.
- For corporations, we use stockholders' equity.
Stockholders' equity represents the portion of total assets that is left to the stockholders of a corporation after all of its liabilities are paid.
Stockholders' equity (SHE) has 3 major components: Capital Stock, Retained Earnings, and Treasury Stock.
SHE = Capital Stock + Reserves + Retained Earnings - Treasury Stock
Capital Stock or Share Capital represents contributions from stockholders gathered through the issuance of stocks. Retained Earnings or Accumulated Profits represents company earnings from the time it started minus dividends distributed, and after considering other adjustments. Treasury Stocks are shares issued by the company and were later re-acquired. The cost of treasury stocks is deducted from stockholders' equity.
A fourth component is known as Reserves. If a corporation has reserves, it is normally presented after Capital Stock and before Retained Earnings in the balance sheet. Reserves include unrealized gains and losses, appropriations, and additional paid-in capital.
Here is a list of stockholders' equity accounts.
Capital Stock / Share Capital
- 1. Common Stock - also known as Ordinary Shares. It represents ownership in a corporation. Common stockholders are given rights to receive dividends and voting rights in electing a board of directors.
- 2. Preferred Stock - also known as Preference Shares. Preferred stockholders enjoy fixed dividend rates and are paid first before the common stockholders. Preferred stocks normally do not possess voting rights, unless stated.
- 3. Subscribed Capital Stock - common or preferred stocks subscribed but not yet paid, hence not yet issued
- 1. Additional Paid-in Capital - also known as Share Premium; contribution from stockholders in excess of the par or stated value of the stocks issued
- 2. Unrealized Gains and Losses - gains and losses that cannot be included in the income statement as per accounting standards, such as Unrealized Gain/Loss on Financial Assets and Unrealized Gain/Loss on Translation Adjustment
- 3. Revaluation Surplus - increase in the value of a fixed asset after an appropriate appraisal
- 4. Retained Earnings Appropriated - company's earnings set aside for a specific purpose (such as Retained Earnings Appropriated for Plant Expansion), hence cannot be distributed as dividends to the stockholders
The Retained Earnings account represents the accumulated earnings of the business from the time it first started. It is also known as Accumulated Profits. The amount presented in the balance sheet at the end of the year is computed using this formula: Retained Earnings at the beginning of the year (after adjustments, if any) plus net income, minus appropriations made for specific purposes, and minus dividends declared during the year.
Treasury stocks are shares of the corporation that have been issued and then were reacquired but not cancelled. In the balance sheet, the cost of treasury stock is shown as a deduction to Stockholders' Equity.