Statement of Changes in Equity in Simple Words
Statement of Changes in Equity shows what caused the owner’s equity to increase or decrease in a certain period.
Business owners or investors are often curious about how much equity has changed in a business throughout a certain period (usually a year), similar to how homeowners and car owners often wonder about their equity after making several years of loans/mortgage payments.
A quick recall: Equity can be changed by the following activities:
- Net Income (Increasing Equity) or Net Loss (Decreasing Equity) from the same period
- New investment received or new stocks issued (Increasing Equity)
- Distribution/Dividend (Decreasing Equity)
The Statement of Changes in Equity lists those changes, as Balance Sheet would only show an ending balance of those accounts.
Purpose of Statement of Changes in Equity
As one of the four financial statements, the main purposes of the Statement of Changes in Equity are
- To show owners what’s changed to their equity or ownership in the business after a period of operation, including new profit earned (retained earning) or new investment made from existing or new owners/investors
- To show investors how the business handles its profit. For example, investors can learn how the business distributes its profit (through dividends, etc.)
Many smaller companies explain the ownership change as a footnote to their financial reports instead of publishing a Statement of Changes in Equity. However, most large, publicly traded companies prepare a Statement of Changes in Equity as it provides transparency for the investors or audience to gain insights into its ownership structure.
Two Formats of Statement of Changes in Equity
There are two popular ways to present Statement of Changes in Equity.
- Horizontal Format
- Easy to understand, suitable for small businesses.
- It lists the beginning balance at the top, then the activities (increasing or decreasing) in the middle, which calculates the ending balance at the bottom. Very Straightforward.
- Vertical Format
- Large, publicly traded companies more widely use it.
- Each type of equity account has its own “column” (ex: Retained earnings, APIC etc.) Then, those columns detail what adds or subtracts the account balance.
Both Formats lead to the same result and perform the same function: to reconcile the beginning balance to the ending balance. See below for an example of both.
Real-world Simple Examples
Pho my Life Noodle Shop (PML) presented its Statement of Changes in Equity for the year ended 12/31/2024:
- The more straightforward, horizontal format is like a ledger, where a beginning balance is presented first ($20,000). This is the balance before the year starts.
- The following two items are what changed the owner’s equity.
- Retained earnings of $3,000 is the net income of the year ended 12/31/2024, which increases the equity balance.
- Additional owner’s investment of $2,500 – this is the amount the owner contributed to the business out of his pocket, which adds to the equity balance of the business.
- The last line is the final result, or ending balance, calculated by adding the activities ($3,000 + $2,500) to the beginning balance ($20,000), which gave us the ending balance of $25,500 for the year ended 12/31/2024.
- Vertical formats are built in “columns,” where each column represents each equity account. In this simple example, we will only have two – “Retained Earnings” and “Contributed Capital/Owner’s Investment.”
- Each row shows one activity that changes the equity accounts. Similarly to the horizontal format, the row starts with the beginning balance at the top and the ending balance at the bottom, with the rows in the middle representing the activities.
- For the retained earnings Column, the beginning balance is zero (suppose PML Noodle Shop is a new restaurant that opened its door on 12/31/23, therefore, no retained earnings had been rolled over from the previous year). After a year of operation, the net income of $3,000 will then increase the retaining earnings account, also bringing the ending balance of retained earnings to $3,000 ($0 beginning balance + $3,000 Net Income)
- For the Contributed Capital/Owner’s Investment column, the beginning balance is $20,000 (Suppose the owner of PML started the business with $20,000 out of his pocket on 12/31/23). Throughout the year, the owner also made an additional investment to the company for $2,500, which then brings the ending balance of this account to $22,500 ($20,000 beginning balance + $2,500 additional investment)
- The last column summarizes all these activities and perfectly calculates how the business went from $20,000 in the beginning balance to $25,500 at the end of the year by including the $3,000 Net Income and $2,500 additional contribution. In other words, the last column is very similar to the horizontal format mentioned above.
Other Common Activities Presented in the Statement of Changes in Equity
Outside of Net Income/Retained earnings and Investment/Contribution to Capital, here is a list of other activities often seen in the Statement of Changes in Equity.
- Stock Insurance
- This would increase the account “Common Stock” and “Additional Paid in Capital/APIC”
- Dividends Distributed
- This would decrease the “Retained Earnings” account
- Purchase of Treasury Stock
- This would increase the “Treasury Stock” Account (which is an account with debit balance, or contra equity account – meaning the increase of this account would decrease the equity balance)
- Other Comprehensive Income (OCI)
- This would increase the “Accumulated Other comprehensive Income” Account
Q: What’s the difference between Statement of Changes in Equity vs. Statement of Retained Earnings
A: They are the same thing. Statement of Changes in Equity is also known as Statement of Retained Earnings, although large, publicly traded companies more commonly use the former.
Q: What’s the format of Statement of Changes in Equity?
A: There are two formats: Horizontal Format and Vertical Format. See above for a simple example of each.
Q: Why Statement of Changes in Equity is important?
A: The Statement of Changes in Equity is important because it provides transparency into a company’s ownership changes and helps investors gauge how profits are distributed.
Q: What’s the difference between Statement of Changes in Equity and Balance Sheet
A: They are two different kinds of financial statements. Statement of Changes in Equity is widely seen as an expansion to the equity section of the Balance Sheet. The Balance Sheet only shows the ending balance of the equity accounts, while the Statement of Changes in Equity shows the beginning balance, activities during the period, and ending balance of all equity accounts, including retained earnings.
Q: Is Statement of Changes in Equity mandatory or required?
A: Businesses are usually required to report any changes to their Shareholder’s Equity, but the method of reporting may vary. Big, publicly traded companies usually use a Statement of Changes in Equity to fulfill this requirement. However, smaller firms may opt to write a footnote that explains the activities instead.