Statement of Changes in Equity and the Balance Sheet

Study Guide

I. The statement of changes in equity presents the organization's detailed changes in each
equity account over the course of the period presented. The accounts typically
presented in the statement of changes in equity include the following:
A. Preferred Stock: Contributed capital for non-voting stock which generally carries
a stated dividend rate that will be paid first in the event the organization
declares a dividend.
1. Generally non-voting stock ownership.
2. Generally carries a specified dividend rate stated as a percentage of par
value. For example, a $100 par 8% preferred share would be entitled to
an $8 dividend annually if the organization declared dividends. Preferred
Stock dividends must be paid before any common shareholders receive
dividends from the organization.
3. May be convertible into common stock at a specified conversion ratio.
4. May be callable at a specified price at the option of the organization.
5. Behind company creditors, but ahead of common shareholders for
preference in the case of bankruptcy or other liquidation of the
organization.
B. Common Stock
1. Usually carried at par value unless the stock is “no par” stock, in which
case the entire amount paid for the stock is classified as common stock.
2. Dividends are not predetermined like preferred stock and are only paid
when declared and only then, after the preferred shareholders receive
their stated dividend.
3. Last in line for preference in the case of bankruptcy or other liquidation.
C. Additional Paid-In Capital
1. Amount received by the organization for stock over the par value of the
shares.
2. Can be affected by various equity transactions, including stock dividends,
resales of treasury stock, and issuance of options and warrants.
D. Treasury Stock
1. Amount paid by the organization to repurchase its own stock
2. Shown as contra equity, or a reduction to the equity section
E. Retained Earnings
1. Net income or loss for the organization is ultimately recorded in retained
earnings.
2. Dividends declared are a reduction to retained earnings.
F. Accumulated Other Comprehensive Income
1. Other comprehensive income or loss for the organization is ultimately
recorded in Accumulated Other Comprehensive Income.
 2. Items accumulated here are not part of the calculation of net income.
G. Non-Controlling Interest
1. When an organization has a controlling interest in another entity, but not
complete ownership, 100% of the assets and liabilities of the subsidiary
are included in the balance sheet of the organization and the portion of
the subsidiary that is owned by third parties is segregated as a separate
component of equity.
II. Several common transactions affect the equity accounts.
A. Sale of new shares: Generally sold for an amount above par value. Cash received
is recorded and the common stock/preferred stock account is increased for the
par value and the additional paid-in capital account is increased for the balance.
B. Issuance of options: Usually issued as a form of compensation and recorded as
part of additional paid-in capital as compensation expense is recognized.
1. Total compensation expense is valued at the fair value of the options on
the date they are granted.
2. Compensation expense is recognized over the service period required for
the employee to become vested in the options.
C. Dividends: Retained earnings is reduced when a cash dividend is declared. If
payment of the dividend is delayed, a payable is also recorded and then reduced
when the payment is later made.
D. Net Income/Loss: Increases/Decreases retained earnings each year.
E. Other Comprehensive Income Items: Increase/Decrease accumulated other
comprehensive income each year.
F. Repurchase of treasury stock: Treasury stock is increased (which is a reduction to
equity) for the cost of the treasury shares.
G. Resale of treasury stock.
1. When sold for an amount in excess of the repurchase price, the cost is
taken out of treasury stock and the excess is added to additional paid-in
capital.
2. When sold for an amount below the repurchase price, the cost is taken
out of treasury stock and the difference is taken from additional paid-in
capital to the extent it was previously increased for treasury stock
transactions. If no additional paid-in capital from treasury stock
transactions exists, the difference is taken from retained earnings.
H. Stock split: Generally has no impact on any of the equity accounts as long as the
par value is also changed to reflect the new share size. For example, if 100 shares
of $1 par common stock undergo a 2-for-1 stock split, the result would be 200
shares of $0.50 par common stock. Common stock is $100 before the split (100 
× $1) and is still $100 after the split (200 × $0.50) so no journal entry is needed.
I. Stock dividends: A stock dividend occurs when an organization distributes
additional shares of stock to existing stockholders as a dividend rather than
paying them cash.
1. Small stock dividend: Less than 20–25% of the number of shares
outstanding. Retained earnings is reduced for the fair value of the stock
 being issued, common stock is increased for the par value of the stock
issued, and the difference is included in additional paid-in capital.
2. Large stock dividend: Greater than 20–25% of the number of shares
outstanding. Retained earnings is reduced for the par value of the stock
being issued and common stock is increased for the same amount. No
impact on additional paid-in capital, similar to a stock split.

Practice Question

Jolley, Inc. has 100,000 common shares outstanding with a $1 par value
and a market value of $8. Jolley declares a 22% stock dividend.

What is the impact on the various equity accounts if the transaction is

considered a small stock dividend?

What is the impact on the various equity accounts if the transaction is

considered a large stock dividend?

Answer

1. A small stock dividend is recorded at fair value. 22,000 new shares

are issued (100,000 × 22%) and the fair value of $176,000 is taken
from retained earnings (22,000 × $8), common stock is increased
by $22,000 (22,000 × $1) to reflect the par value of the new
shares and the balance of $154,000 ($176,000 − $22,000) is
recorded as an increase to additional paid-in capital.
2. A large stock dividend is recorded at par value. 22,000 new shares
are issued (100,000 × 22%) and the par value of $22,000 is taken
from retained earnings (22,000 × $1) and common stock is
increased for the same amount.
III. Illustration: The basic format for the statement of changes in equity is illustrated using
ABC Co. information for 20X2.
IV. The balance sheet shows the organization's assets, liabilities, and owners’ equity as of
the end of the period presented. The balance sheet is the only one of the four main
financials statements that presents information as of a point in time, rather than over a
period of time. The classic accounting equation “assets = liabilities + equity” is illustrated
through the balance sheet.
A. Assets represent the resources available to the organization for carrying out its
purpose. Assets are presented in order of liquidity within two general categories,
current or non-current, based upon the period of time the assets are expected to
convert to cash.
1. Cash, accounts receivable, inventory, prepaid assets, and other items
expected to be realized within one year (or the operating cycle if longer)
are classified as current.
2. Property and equipment, intangible assets, and other assets expected to
benefit the company for longer than one year (or the operating cycle if
longer) are classified as non-current.
B. Liabilities represent third party claims to the assets of the organization. Liabilities
are the amounts owed by the organization to third parties, such as debt,
accounts payable, or wages payable. Liabilities are presented in the order they
come due within two general categories, current or non-current, based upon the
period of time before assets or other resources of the company will be utilized to
satisfy the liability.
1. Accounts payable, accrued expenses (wages, utilities, rent, etc.), deferred
revenue, principal portions of long-term debt due in the coming year, and
other liabilities expected to be settled with cash or other current assets
within one year (or the operating cycle if longer) are classified as current.
2. Liabilities due after one year (or the operating cycle if longer), such as
bonds or bank debt, are classified as long-term. In addition, deferred tax
liabilities are considered long-term liabilities by definition.
 C. Equities represent owner claims to the assets of the organization. These
accounts were explained in part I of this lesson.
1. Equity accounts are generally presented in order of liquidation
preference with preferred stock first, followed by common stock and
additional paid-in capital. Retained earnings and accumulated other
comprehensive income are generally presented last in the equity section.
D. The balance sheet is incomplete without the additional disclosures in the notes
to the financial statements. These disclosures help investors understand the key
assumptions and methods of accounting used so they can more effectively
compare prior periods and assist with comparisons with other companies. Key
disclosures include the following items.
1. Significant accounting policies, including the following:

1. Any securities classified as cash equivalents

2. Inventory valuation method and cost flow assumptions
3. Method of depreciation
2. Significant estimates made within the accounts
3. Amounts within major classes of inventory (i.e., raw materials, work in
process, finished goods)
4. Gross amounts within major classes of property and equipment (i.e.
furniture, equipment, buildings, land) and accumulated depreciation for
each
5. Components of deferred tax assets and liabilities
6. Expected annual principal payments on debt for the next five years and
all amounts due thereafter
7. Sinking fund provisions for bonds
8. Par values and contractual provisions for preferred stock and common
stock
9. Details about employee stock compensation programs
10. Significant commitments or contingencies not recorded in the balance
sheet
11. Other information as may be needed for a full understanding of the items
reported in the balance sheet
b. Illustration: The basic format for the balance sheet is illustrated using ABC Co.
information for 20X2.
Practice Question
Jolley, Inc. is preparing its 20X1 balance sheet and needs some assistance with properly
classifying some of its liabilities. Jolley's operating cycle is approximately 90 to 120 days.
Identify whether the following items should be current or non-current on the balance sheet.

1. Debt of $10,000 payable over 5 years at a rate of $2,000 per year plus interest.
2. Bonds of $100,000 due in full in 15 years. Interest of $6,000 is payable on the bonds
each year and the full amount of the interest was already recorded and paid for 20X1.
Accordingly, no interest payable was recorded at the end of the year.
3. Deferred Tax Liability of $3,000 expected to reverse entirely within the next year.
4. Accrued Warranty of $12,000 expected to be paid out evenly over the next three years.
5. Accounts Payable of $38,000 generally due between 30 and 90 days.

Answer

1. Because $2,000 is due in the coming year and the remainder is due thereafter, this debt
should be classified as current for $2,000 and non-current for $8,000.
2. Because the principal portion of the bonds is not due for 15 years, the entire amount
should be classified as non-current. Jolley has fully paid its interest for the year, so they
 have no need for a payable associated with the interest. Classification of the interest is
not relevant.
3. By definition, Deferred Tax Liabilities are non-current liabilities.
4. The accrued warranty should be split as current and non-current based on the expected
payments related to the warranty. $4,000 would be current and $8,000 would be non-
current.
5. Because the amount is expected to be paid within the next year, the entire amount is
current.

Summary
The statement of changes in equity presents the organization's detailed changes in each equity
account over the course of the period presented. The accounts typically presented in this
financial statement include: preferred stock, common stock, additional paid-in capital, treasury
stock, retained earnings, accumulated other comprehensive income, and non-controlling
interest. You should be familiar with the common transactions that affect equity accounts. The
balance sheet shows the organization's assets, liabilities, and owner's equity as of the end of
the period presented. Assets represent the resources available for carrying out the
organization's purpose and can be current or non-current. Liabilities represent third-party
claims to the organization's assets and are also represented as current or non-current. Equities
represent owner claims to the organization's assets. It is also important to know the key
disclosures related to the balance sheet.

Slides
FLASHCARDS
Which accounts are typically presented in the statement of
changes in equity?
 Preferred Stock
 Common Stock
 Additional Paid-in Capital
 Treasury Stock
 Retained Earnings
 Accumulated Other Comprehensive Income
 Non-Controlling Interest

Explain the effect on the financial statements of the

repurchase of treasury stock and the resale of treasury
stock.
 Purchase of Treasury Stock: Treasury stock (a contra equity account)
increases for the cost of the shares, which reduces equity.
 Resale of Treasury Stock: When stock is resold for greater than the
repurchase price of the stock, the cost is taken from treasury stock and
the excess is added to additional paid-in capital. When stock is resold
for an amount lower than the repurchase price, the difference is taken
from additional paid-in capital and retained earnings if there is not
sufficient additional paid-in capital from previous resales of treasury
stock.

Explain the events of stock splits and stock dividends.

 Stock Split: Does not impact the equity accounts as long as the par value is
changed to reflect the new share size.
 Stock Dividends: A small stock dividend is less than 20–25% of the number of
outstanding shares. Retained earnings is reduced for the fair value of stock,
common stock is increased for the par value, and the difference is included in
additional paid-in capital. For large stock dividends (greater than 20–25%),
retained earnings is reduced and common stock is increased for the par value of
the stock issued in the dividend.
Explain:
 Three major sections included on a balance sheet
 Footnote disclosures
 Assets: The resources available to the organization for carrying out its purpose.
Divided into a current and non-current portion.
 Liabilities: Represent third-party claims to the assets of an organization.
Divided into a current and non-current portion.
 Equities: Represent the owner claims to the assets of the organization.
 Footnote Disclosures: The disclosures help investors understand key
assumptions and methods used to better compare financial statements between
organizations.

Question 1 
aq.soc.001_1802
Which of the following is true of disclosure requirements of accounts receivable?
Receivables should be reported net of any valuation accounts on the balance sheet.
The monthly change in credit sales and accounts receivables should be reported as part of
footnotes.
Accounts receivables should not be reported as a separate line item when payment terms
extend beyond 30 days.
Accounts receivable should be classified as noncurrent assets.
 This Answer is Correct
This answer is correct. Receivables should be on the balance sheet and reported net of
any valuation accounts.
Question 2 
aq.soc.002_1802
Ashe Corp. was organized on January 1, Year 1, with authorized capital of 100,000
shares of $20 par value common stock. During Year 1 Ashe had the following
transactions affecting stockholders’ equity:
January 10 Issued 25,000 shares at $22 a share.
March 25 Issued 1,000 shares for legal services when the fair value was $24 a share.
September 30 Issued 5,000 shares for a tract of land when the fair value was $26 a share.
What amount should Ashe report for additional paid-in capital at December 31, Year
1?
$80,000
 $54,000
$50,000
$84,000
 This Answer is Correct

Step 1. 25,000 x (22 – 20) = 50,000

Step 2. 1,000 x (24 – 20) = 4,000
Step 3. 5,000 x (26 – 20) = 30,000

This answer is correct. All three transactions increase additional paid-in capital
(APIC) because they involve the issuance of common stock for an amount above par
value. The January 10 transaction increases APIC by $50,000 [25,000 × ($22 − $20)].
The March 25 transaction increases APIC by $4,000 [1,000 × ($24 − $20)] because the
transaction is valued at the FV of the services or the FV of the stock, whichever is
more clearly determinable. Similarly, the September 30 transaction increases APIC by
$30,000 [5,000 × ($26 − $20)]. Therefore, Ashe should report APIC of $84,000
($50,000 + $4,000 + $30,000) at 12/31/Y1.
Question 3 
aq.soc.003_1802
Expanding Company (EC) is a rapidly growing startup company. EC's operating cycle
is 150 days. To fund their growth, EC has taken out several different issuances of debt
financing and has several other liabilities:

 Debt of $3,000,000 payable over 6 years at a rate of $500,000 per year plus
interest.
 Bonds of $20,000,000 due in full in 12 years. Interest of $1,200,000 is payable
on the bonds each year and the full amount of the interest was already
recorded and paid for this year. Accordingly, no interest payable was recorded
at the end of the year.
 Deferred Tax Liability of $800,000 expected to reverse entirely within the next
year.
 Accrued Warranty of $600,000 expected to be paid out evenly over the next
two years.
 Accounts Payable of $1,200,000 generally due between 90 and 120 days.

What is the total amount of EC's current and non-current liabilities?

$1,200,000 current liabilities, $24,400,000 non-current
liabilities
$2,000,000 current liabilities, $23,600,000 non-current
 liabilities
$1,500,000 current liabilities, $24,100,000 non-current
liabilities
$2,800,000 current liabilities, $22,800,000 non-current
liabilities
 This Answer is Correct
Because $500,000 is due in the coming year and the remainder is due thereafter, this
debt should be classified as current for $500,000 and non-current for $2,500,000. (2)
Because the principal portion of the bonds is not due for 12 years, the entire amount
should be classified as non-current. Jolley has fully paid its interest for the year, so
they have no need for a payable associated with the interest. Classification of the
interest is not relevant. (3) By definition, deferred tax liabilities are non-current
liabilities. (4) The accrued warranty should be split as current and non-current based
on the expected payments related to the warranty. $300,000 would be current and
$300,000 would be non-current. (5) Because the entire amount of accounts payable is
expected to be paid within the next year, the entire amount is current. Therefore,
current liabilities are $2,000,000 ($500,000 + $300,000 + $1,200,000) and long-term
liabilities are $23,600,000 ($2,500,000 + $20,000,000 + $800,000 + $300,000).
Question 4 
aq.soc.004_1802
Rogers Electronics is planning to reacquire some of its common shares. Which of the
following is most likely to happen if this is done?
The stock price will increase.
The par value of the stock will increase.
This will hinder exercise of employee stock options.
This could serve as an indication of the company's negative outlook about its future
performance.
 This Answer is Correct
This answer is correct. Reacquisition reduces the number of shares a company has
outstanding and influences the price of the shares due to simple supply and demand.
Therefore, the stock price of the company will increase.
Question 5 
aq.soc.006_1802
On January 2, Year 1, Smith purchased the net assets of Jones’ Cleaning, a sole
proprietorship, for $350,000, and commenced operations of Spiffy Cleaning, a sole
proprietorship. The assets had a carrying amount of $375,000 and a market value of
$340,000. In Spiffy's cash-basis financial statements for the year ended December 31,
Year 1, Spiffy reported revenues in excess of expenses of $60,000. Smith's drawings
during Year 1 were $20,000. In Spiffy's financial statements, what amount should be
reported as Capital-Smith?
$390,000
$380,000
$410,000
$415,000
 This Answer is Correct
This answer is correct. The ending balance in Smith's capital account on either the
accrual or cash basis is computed as follows: Beginning capital + Investments + 
Income − Drawings = Ending capital
Smith's beginning capital balance is measured as the cost of the assets purchased to
establish the business ($350,000). The previously recorded value ($375,000) and
estimated market value ($340,000) do not affect beginning capital. No additional
investments were made; cash basis income was $60,000 and drawings were $20,000.
Therefore, the ending capital balance is $390,000 ($350,000 + $60,000 − $20,000).
Question 6 
aq.soc.007_1802
The latest financial statements of Darlene Properties show 140,000 outstanding
shares, par value $1. At the beginning of the current year, the company reacquired
10,000 shares at $4 per share. The company follows the cost method for the
accounting of treasury stock. The market value per share is $11 at the end of the year.
The current year's records show the shares as follows:
Common stock, $1 par $200,000
Less: Treasury stock 10,000
Net common stock, $1 par $190,000
The company's CFO did not approve of the financial statements. The most likely
reason for the CFO's disapproval is that:
The treasury stock is incorrectly valued based on par value instead of being valued at the
current market rate.
The par value of the treasury stock should be presented as a deduction from par value of
issued shares of the same class.
The treasury stock is incorrectly valued based on par value instead of being valued at the
acquisition price.
The treasury stock should be reported as an asset.
 This Answer is Correct
This answer is correct. In the cost method, the treasury stock account is debited for the
cost of the shares reacquired. Therefore, the value of treasury stocks should be
$40,000 (10,000 shares × $4), valued at the acquisition price.
Question 7 

The following information was abstracted from the accounts of the Oar Corporation at
December 31, Year 2:
Total income since incorporation including Year 2 $840,000
Total cash dividends declared 260,000
Proceeds from sale of donated stock (FV on date of donation was $30,000) 90,000
Total value of stock dividends distributed 60,000
Excess of proceeds over cost of treasury stock sold 140,000
The donated stock did not allow the company to exercise significant influence over
the investee. What should be the current balance of retained earnings?
$580,000
$610,000
$670,000
$520,000
 This Answer is Correct
This answer is correct. Retained earnings is increased by income and decreased by
dividends. Donated assets are recorded at FV upon receipt and recognized as equity in
the period of donation. Equity securities are measured at fair value at the end of each
year, and the gain or loss is included in net income:
Income − Cash dividends − Stock dividends = Retained earnings
$840,000 − $260,000 − $60,000 = $520,000
The excess of proceeds over cost of treasury stock sold would be credited to paid-in
capital.
Question 8 
aq.soc.009_1802
The purchase of treasury stock:
Decreases common stock authorized.
Decreases common stock issued.
Decreases common stock outstanding.
Has no effect on common stock outstanding.
 You Answered Correctly!
This answer is correct because only the common stock outstanding will be decreased
by the amount of treasury stock purchased. When a company reacquires its own stock,
the purchase does not reduce the number of shares issued or authorized, but does
reduce the number of shares outstanding and the total stockholders’ equity.
Question 9 
aq.soc.010_1802
Cash dividends on the $10 par value common stock of Ray Company were as follows:
1st quarter of Year 1 $  800,000
2nd quarter of Year 1 900,000
3rd quarter of Year 1 1,000,000
4th quarter of Year 1 1,100,000
The 4th-quarter cash dividend was declared on December 20, Year 1, to stockholders
of record on December 31, Year 1. Payment of the 4th-quarter cash dividend was
made on January 9, Year 2. In addition, Ray declared a 5% stock dividend on its $10
par value common stock on December 1, Year 1, when there were 300,000 shares
issued and outstanding and the market value of the common stock was $20 per share.
The shares were issued on December 21, Year 1. As a result of the above transactions,
what was the effect on Ray's common stock, APIC, and retained earnings account,
respectively?
$0, $0, $3,800,000 debit
$150,000 credit, $0, $3,950,000 debit
$300,000 credit, $300,000 debit, $3,800,000
debit
$150,000 credit, $150,000 credit, $4,100,000
debit
 This Answer is Correct
This answer is correct. The first step is to prepare the journal entries affecting the
three accounts. The cash dividends should be recorded as a $3,800,000 ($800,000 +
$900,000 + $1,000,000 + $1,100,000) debit to retained earnings with a credit to cash,
for dividends declared and paid, and dividends payable, for dividends declared and
not paid before the end of the year, as illustrated below. Next make the entry for the
issuance of a 15,000-share (300,000 shares × 5%) stock dividend when the market
price is $20/share and par value is $10/share. Because the stock dividend is a small
stock dividend, the fair value of the stock is used to calculate the dividend (15,000
shares × $20 = $300,000), and retained earnings is reduced by that amount. The par
value of the stock is added to common stock (15,000 × $10 = $150,000) and the
remainder is added to APIC ($300,000 − $150,000 = $150,000). Combined together,
the entries result in debits to retained earnings of $4,100,000 and credits to common
stock and APIC of $150,000 each.
Retained earnings 3,800,000
Cash 2,700,000
Dividends payable 1,100,000
Retained earnings 300,000
Common stock 150,000
APIC 150,000