Statement OF Owner Equity Fact Sheets PDF

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Statement OF Owner Equity Fact Sheets...

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STATEMENT OF CHANGES IN OWNER EQUITY AND FINANCIAL PROGRESS What is the Statement of Owner Equity?

The Statement of Changes in Owner Equity summarizes changes to the owner's equity account as a result of transactions that have occurred during a specific period. These changes include contribution by investors, withdrawals by investor and profit during a specific time period. The changes are used in conjunction with the owner equity values from two consecutive balance sheets to review the following:  Financial progress of a firm  How and why owner equity is growing or declining?  Amount of reinvestment of profit made by the firm The statement uses the following format (see below) to show the balances of the owner equity at the beginning and end of the period in addition to the changes that occurred during this period. Be sure that you include the date, statement name, company name and correct headings when creating this and all other financial statements. StatementofChangesinOwnerEquity ABCBusiness YearendingDecember31,2014 Balance:OwnerEquity–December31,2013 (thisisthesamevalueasJanuary1,2014) OwnerContributionduringJanuary1toDecember31,2014  NetIncomeduringJanuary1toDecember31,2014  OwnerwithdrawalduringJanuary1toDecember31,2014  Balance:OwnerEquity–December31,2014 

$100,000 $10,000  $40,000  ($2,000) $148,000

The general format of the statement is the same for all legal structures with three specific differences:  Terms Used: The title and related headings change based upon the legal structure. Use the term Owner's Equity for sole proprietorships, Partners' Equity for partnerships and Stockholders' Equity for corporations. 

Taxes: Net income values will either include or exclude tax paid based upon the legal structure. A corporation’s net income will be net of taxes while sole proprietorships and partnerships report net income prior to taxes being taken off. The reasons for this are based upon the way these different legal structures pay their taxes on their net income. See details for business structures in

Management and Business Structure factsheet. 

Withdrawal versus Dividends: Partnerships and sole proprietors use the term withdrawals because they can legally withdraw directly from the business. Shareholders of corporations are paid dividends and thus the term dividends is used in the statement

See example below for details.

Articulating the Financial Statements: Timing and Linkages

Timing When developing the Statement of Changes in Owner Equity it is important to be clear on the timing and the linkages between the statement of owner equity, net income accrued and balance sheet statements. Remember that the timing of the balance sheet is at one point in time (e.g., December 31, 2014) while the net income statement and statement of changes in owner equity is over a time period (e.g., January 1 to December 31, 2014). Linkages In terms of linkages, the net income statement is a link between balance sheets because it provides the results of operations in terms of business net income loss or gains — one important part of the change in owner's equity. As well, the statement of changes in owner equity is often viewed as the connecting link between the income statement and balance sheet. The diagram below shows the flow of cash, shareholder equity and net income and their effect on the statements.

The diagram below illustrates the timing between the balance sheet and the net income statement over a one-year period. Balance Sheet Dec 31, 2013

Balance Sheet Dec 31, 2014 Income Statement During January 1, 2014 to December 31, 2014

Time

The diagram below illustrates the linkages between the balance sheet and the statement of changes in owner equity. Owner Equity: Balance Sheet Dec 31, 2013

Owner Equity: Balance Sheet Dec 31, 2014

+ Owner Contribution during January 1 to December 31, 2014 + Net Income during January 1 to December 31, 2014 - Owner withdrawal during January 1 to December 31, 2014

Time

Financial Progression

Financial progression is defined as the increase of owner equity (e.g., increase assets or decrease liabilities) via the profits of the firm and is a goal of most owners/shareholders. Owner equity can increase via owner investment and profit reinvestment. However, only reinvestment of business profit is considered financial progress. Note that reinvested income is also referred to as retained earnings. When a firm reinvests their profit in the business what they are really referring to is the firm putting the profit into business savings account deposits, equipment purchases, new supplies and technology upgrades or decreasing liabilities by paying off operating loans, decreasing balances of supply bills or paying principal on mortgages. These balance sheet transactions will result in an increase of owner equity and financial progress. See examples and uses of the accounting equation in the Balance Sheet factsheet for more details. Financial progress is a goal because owners and manager want the business to grow and their owner equity to increase. Thus, owners only want their business profit to be reinvested if it will be used to make more money or save money for the firm. For example, if $20,000 of profit is reinvested into the firm to buy new factory equipment, then the owner would expect this new asset to earn profit of more than $20,000 over time which the owner could either withdraw or reinvest to make their owner equity increase. If the reinvestment does not have these results, then it is not a good idea to reinvest money to the business. Review the following example to understand what transactions are considered financial progress Example: Reviewing Financial Progress: A Simple Example A new consulting business has started up with an owner investment of $15,000 and a $5,000 bank loan that was used to purchase computer equipment of $20,000. The business has no liabilities or other assets. Each year the business owner earns profit of $15,000 which she invests back into the firm as either new equipment or cash in the bank. In year one they pay off all liabilities and then use the residual to buy assets. In year two they reinvest the whole amount in assets. Is this firm financially progressing? Use the balance sheet to assess the progress at the beginning of each of the next three years. Beginning During Beginning Beginning of Year During of Year Year of Year One Year One Two Two Three Asset $20,000 Net $30,000 Net $45,000 Income of Income $0 $0 Liability $ 5,000 $15,000 of Reinvested $15,000 Owner $15,000 $30,000 $45,000 Equity The firm has been financially progressing because the owner equity has increased using profits from the firm. As a result the owner equity has increased from $15,000 to $45,000. Be clear that owners get to choose if they would like to withdraw or reinvest profits. However, if they do choose to reinvest they would do that only if that money would make them more money in the long run op eration of the business.

Only the balance sheet statement and not the net worth statement is used to accurately develop the statement of changes in owner equity because in the balance sheet the assets are valued at book value (net) at one point in time. This means that changes in market fluctuations are not included in the book value (net) of asset so that any increase of assets tracked in the year to year balance sheets must be the result of either business profit reinvestment or owner investment.

Applications of the Statement of Owner Equity

Financial Progress Assessment The statement of changes of owner equity provides a detailed view of the financial progress, how and why owner equity has changed and the amount of reinvestment of profit made by the firm Example: Review the contribution, withdrawal and net income levels to determine how much of each was contributing to the progress of the firm. For example, if a firm’s owner equity increased by $100,000, the statement can reveal the transactions that increased the owner equity value.

Define Missing Components The statement of changes in owner equity can be used to determine one of these components of the statement if it is unknown. Example: It is common for small businesses to draw funds from their business throughout the year to use for living costs. It is also common for small business owners to not keep track of these amounts. This would be considered a withdrawal and would decrease owner equity. Thus, the statement can be used to solve the unknown component or even used as a check figure.

Questions for Review

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Example

Why is financial progress an important goal? And for whom? How can financial progress be tracked? Net Worth? Balance Sheet? Why or Why Not? How does the owner/s equity related to business structure? What is meant by the term financial progression? How is it measured? Would it ever be helpful or possible to use a net worth value instead of owners’ equity in the statement of changes in owner equity? Why or why not? How does the statement differ for the various business structures? Net Income? Format? Withdrawals? Contributions? If the owner indicated she did not withdraw any money from the business and you are not sure you believe her could you find the information in the statement of owner equity? Can you tell how a business is paying off its debts from this owner equity statement?

Assume that a service type sole proprietorship business started the year 2014 with $100,000 owner equity. During the year, the owner made $10,000 additional contributions and $20,000 total withdrawals. In addition, the business had a net income of 55,000 and will need to pay 8,000 taxes on income. Develop the Statement of Changes in Owner's Equity and comment on the financial progress of the firm.

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The owner equity has increased and financial progression accomplished mainly due to the $55,000 net income. However, the progression has also been assisted by new contributions of $10,000 and hindered by withdrawals of $20,000. Taxes have also been paid but this of course is a legal requirement. The business owner is a sole proprietor and thus can withdraw whatever they want or need. However, it would be good to investigate if the withdrawals are hindering progress for the firm in terms of limiting access to funds that could be used for new and productive assets, pay down high interest debt or if the amount is ongoing or expected to increase over time.  Accounting Basics for Students: Statement of Owner Equity  http://www.accounting-basics-for-students.com/statement-of-ownersequity.html  Accounting Coach: Calculating a Missing Amount within Owner's Equity http://www.accountingcoach.com/accounting-equation/explanation/6...