Discuss shareholders' equity, how it is measured and disclosed

Answer 1

SHAREHOLDERS' EQUITY MEASUREMENT AND DISCLOSURE

Shareholders' equity is a residual interest or claim—that is, the owners (shareholders) of a firm have a claim on assets not required to meet the claims of creditors. The measurement of the assets and liabilities on the balance sheet therefore determines the measurement of total shareholders' equity. The accounting process also provides an independent derivation of the amount of shareholders' equity.

Corporate laws within many jurisdictions require that, within shareholders' equity, firms distinguish between amounts received from owners and amounts generated by operations which the firm has not distributed to owners. The amounts that firms report as received from owners are equal to the amounts the firm received when it originally issued those shares. Many firms further disaggregate the initial amounts they received from shareholders for common shares into the par or nominal or stated value of the shares and the amounts received in excess of this value, called additional paid-in capital (APIC), share premium, or capital contributed in excess of par value. The firm assigns the par value of a share of stock at an amount it chooses. Par values are typically small, often $1 or less per share, and rarely equal the amounts the firm receives when it issues the shares. The sum of the par value amount and the additional paid-in capital amount is the total amount received from shareholders for the shares when the firm first issued them. This total amount is also called contributed capital or paid-in capital.

Any subsequent sale of common shares from one investor to another (such as occurs on public stock exchanges) has no effect on the recorded amounts of shareholders' equity. The issuing firm does not take part in those transactions. As a result, in a rising stock market, the total paid-in capital amount reported on a balance sheet will usually be less than the current market value of the common shares. The balance sheet amount of shareholders' equity does not, and is not intended to, provide the user of the financial reports with a measure of the market value of common equity. The user can, however, easily ascertain market value of common equity for a given publicly traded firm by looking up the most recent share price (as reported in various online services) and then multiplying this share price times the number of common shares outstanding, as reported on the balance sheet.

Retained earnings measures the net assets generated by a firm from operations exceeding dividends declared. The Retained Earnings account accumulates the amounts of these undistributed earnings over time. When the firm has accumulated losses, rather than profits, the account is typically called Accumulated Deficit rather than Retained Earnings. Retained earnings are a source of financing for assets. Retained earnings are not cash or other assets. Retained earnings represent the source of net assets generated by the earnings process that exceed the firm's dividend declarations. In contrast to liabilities and contributed capital, which common practice refers to as external financing, common practice refers to the process of curtailing dividends to accumulate assets, represented by retained earnings, as internal financing.