Question

Explain/discuss how stockholders’ equity is reported and analyzed.

Answer 1

Stockholders' equity is the amount of assets remaining in a business after all liabilities have been settled. It is calculated as the capital given to a business by its shareholders, plus donated capital and earnings generated by the operation of the business, less any dividends issued. On the balance sheet, stockholders' equity is calculated as:

Total assets - Total liabilities = Stockholders' equity

An alternative calculation of stockholders' equity is:

Share capital + Retained earnings - Treasury stock = Stockholders' equity

A number of accounts comprise stockholders' equity, which typically include the following:

1.Common stock. This is the par value of common stock, which is usually $1 or less per share. In some states, par value may not be required at all.

2.Additional paid-in capital. This is the additional amount that shareholders paid for their shares, in excess of par value. The balance in this account usually substantially exceeds the amount in the common stock account.

3.Retained earnings. This is the cumulative amount of profits and losses generated by the business, less any distributions to shareholders.

4.Treasury stock. This account contains the amount paid to buy back shares from investors. The account balance is negative, and therefore offsets the other stockholders' equity account balances.

How stock equity is reported:

Both calculations result in the same amount of stockholders' equity. This amount appears in the balance sheet, as well as the statement of stockholders' equity.

How stock equity is analysed:

The stockholders' equity concept is important for judging the amount of funds retained within a business. A negative stockholders' equity balance, especially when combined with a large debt liability, is a strong indicator of impending bankruptcy.

Stockholders' equity can be referred to as the book value of a business, since it theoretically represents the residual value of the entity if all liabilities were to be paid for with existing assets. However, since the market value and carrying amount of assets and liabilities do not always match, the concept of book value does not hold up well in practice.

Stockholders Equity provides highly useful information when analyzing financial statements. In events of liquidation, equity holders are later in line than debt holders to receive any payments. This means that bondholders are paid before equity holders. Therefore, debt holders are not very interested in the value of equity beyond the general amount of equity to determine overall solvency. Shareholders, however, are concerned with both liabilities and equity accounts because stockholders equity can only be paid after bondholders have been paid.