Owner's Equity on the Balance Sheet
Owner's Equity on the Balance Sheet
Owner's Equity on the Balance Sheet
The last section on a balance sheet is Owner's Equity, which represents the amount of assets a business owns. Also named net assets, Owner's Equity is simply the difference between total assets and total liabilities. Owner's Equity allows for a company to analyze the company's progress over a point in time. For instance, if a company has high equity and wishes to expand the business, it is more likely that an institution will lend funds. Also, Owner's Equity is the basis for an asking price when a company wishes to sell the business, so the higher the equity, the better. The following categories of the Owner's Equity section are specific to a corporation, since the terminology for a proprietorship or partnership would be reported differently. The first category of Owner's Equity is paid-in capital, followed by retained earnings, treasury stock and accumulated other comprehensive income.
The first category of Owner's Equity is paid-in capital. The different types of shares are listed below this category and they are common stock, preferred stock and additional paid-in capital which signify the amounts invested in the corporation by stockholders. Both common stock and preferred stock reflect par value of the stock, or the amount that investors paid when the company issued shares. Common stock owners are general owners and do not receive a fixed dividend to be paid, therefore, returns are uncertain, and shareholders may not even receive a return at all some years. This is because common stock owners are the last to be paid, receiving payment after preferred stock owners, bondholders and creditors. Therefore, preferred stockholders receive a fixed dividend as well as a share in liquidation proceeds (if a company liquidates). While preferred stockholders receive higher claims on assets and earnings, common stock usually appreciates over a longer period of time, outperforming preferred stocks and bonds.
Also reported next to the stocks are the numbers of authorized, issued, and outstanding shares. Authorized shares state the maximum amount of shares the company is legally permitted to issue. Issued shares are the number of stock that have been issued or sold to shareholders and outstanding shares are the number of shares of a specific stock held by shareholders. The last sub-category of paid-in capital is additional-paid in capital which is the excess of the amount paid by the investor over the par value price of the stock issued.
The next category reported in Owner's Equity is retained earnings. Retained earnings is the percentage of net earnings not paid out as dividends to shareholders, but retained by the company. Retained earnings are then reinvested in the business or used to pay debt. To calculate retained earnings on the Balance Sheet, you must add net income to the beginning retained earnings and subtract any dividends paid to shareholders. This is represented in the following formula:
Retained Earnings (RE)= Beginning RE + Net Income Dividends
When cumulative net income is less than cumulative losses and dividends, retained earnings will result in a negative balance, also known as accumulated deficit.
The next category is treasury stock. Treasury stock is when a company purchases shares in their own stock. This is reported as a contra owner's equity account, since treasury stock is deducted from the sum of paid-in capital and retained earnings. When treasury stock is sold, the difference between the cost and any proceeds received is documented in the additional Paid-in capital account.
The last category listed underneath Owner's Equity is accumulated other comprehensive income (Loss). This category measures the gains and losses of a business that have not been realized. Some of the gains and losses include cumulative foreign currency, net of related income taxes, pension costs and loans that customers have yet to pay off.
As stated above, Owner's Equity is the last section on the Balance Sheet, and perhaps the most important. The categories include paid-in capital, retained earnings, treasury stock and accumulated other comprehensive income. Paid-in capital shows the amounts invested in the corporation by shareholders, and is either common or preferred stock, preferred being the least risky. Retained earnings are the amounts leftover after dividends have been paid and are reinvested into the company. Sometimes, a company will even purchase shares of their own stock, and this is recorded under treasury stock on the balance sheet. Lastly, all other gains and losses that have not been recognized are recorded under accumulated other comprehensive income. Once Owner's Equity has been recorded, the Balance Sheet is complete and the company can then analyze their progress using this information.
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