Chapter 3 statement of change in equity

STATEMENT OF
CHANGE IN
EQUITY
CHAPTER 3

LEARNING OBJECTIVES
By the end of the chapter, the student should be able to:
1. understand the purpose of the Statement of Changes
in Equity;
2. appreciate that the presentation of the Statement of
Changes in Equity is dependent on the form of
business organization;
3. identify the elements of the Statement of Changes in
Equity;
4. determine the nature of the different equity accounts
used by corporations; and
5. prepare a Statement of Changes in Equity.Fundamentals of Accountancy, Business and Management 2 310/19/2020

The SoCE is prepared to meet the requirements of
the readers to understand the transactions that
caused the movements in equity accounts.
The SoCE is a statement dated “for the year ended”.
The report shows a reconciliation of the beginning
and ending balances of the equity accounts. It
summarizes the equity transactions with the owners
of the business that occurred during the year10/19/2020 Fundamentals of Accountancy, Business and Management 2 4

Balance, January 1, 2017 P 100,000.00
Balance, December 31, 2017 P 150,000.00
Equity transactions
with owners
Objective of Statement of Changes in Equity
10/19/2020 Fundamentals of Accountancy, Business and Management 2 5

There are three basic forms of business organizations,
namely; (1) sole proprietorship, (2) partnership, and
(3) corporation. They differ in terms of number of
owners, legal personality of the business, and ease of
transferability of ownership.

• The simplest form of business
organization.
• There is only one owner referred to as
sole proprietor. Oftentimes, the owner is
also the manager.
• The business has no legal personality
separate from its owner.

• In the eyes of the law, the business and the
owner is one entity. For example, the
business and the owner are taxed as one.
• Also, the claim of the creditors of the
business extends to the personal assets of
the owner.
• As a result, raising capital for the business is
constrained to the owner’s resources and
credit standing.10/19/2020 Fundamentals of Accountancy, Business and Management 2 8

• A business owned by two or more
owners called partners.
• They pool their together such as
money, property and industry, to
operate a business and divide the
profit among themselves.

• Partners are generally involved in
the management of the business.
• The agreement of the partners is
stated in the contrast of partnership
specifically, the partners’ profit and
loss sharing arrangements.

• The most complex form of business
organization.
• Owned by many owners called
stockholders or shareholders.
• Ownership is divided into common
stocks or shares. One shareholders can
own many stocks.

• The Corporation Code governs all
corporations in the Philippines.
Corporations are registered with the
Securities and Exchange Commission (SEC).
Some corporations are listed in the
Philippine Stock Exchange (PSE). This means
PSE provides a platform where investors
can buy and sell stocks of listed
corporations.10/19/2020 Fundamentals of Accountancy, Business and Management 2 12

• One of the characteristics of a corporation
is the separation of ownership and
management. Shareholders invest their
funds and the corporations is managed by
professional managers. Stockholders have
limited liability. Creditors of corporation
only have claims to the corporation’s assets.
A corporation is a legal entity separate from
its owners.10/19/2020 Fundamentals of Accountancy, Business and Management 2 13

The form of business organization determines
the equity accounts reported on the financial
statements. As we have reviewed, the form of
business organization differ in terms of
number of owners and the transferability of
ownership. These inherent characteristics of
business organizations led to the difference in
the presentation of equity.

The SFP and SoCE will present one capital
account because there is only one owner. The
owner’s capital account follows this naming
convention: <Owner’s name>, Capital. If the
name of the sole proprietor is Juan Dela Cruz,
then the name of the account is Juan Dela Cruz,
Capital. The owner’s Capital account has a
normal credit balance.

Accountants use the owner’s Drawings account
to record withdrawals of the owner. The
Drawings account follows the naming
convention for Capital: <Owner’s name>,
Drawings. Entries to this account decrease
equity. It is closed at the end of the year to the
Capital account. It is a nominal account with a
normal debit balance.

Drawings
Debit Credit
Beg balance 0
Withdrawals xxx
End balance xxx
xxx Closing
Final balance 0
Owner, Capital
Debit Credit
xxx Beg Balance
xxx contribution
xxx net income
Withdrawals xxx
xxx End balance
Account of Owner’s Capital
The owner’s Capital account tracks the following
transactions of the owner: (1) capital contributions;
(2) withdrawals; and (3) net income or net loss
generated by the business.

Why is net income closed to the capital
account? Consider this: (a) the net income
generated from the operations of the business is
owned by the owner, and (b) the capital account
represents the part of the business that belongs
to the owners. Therefore, the net income that
belongs to the owner should be included in his
capital account.

The SoCE of a sole proprietorship is basically a summary of the
owner’s capital account. The bottom-line of the SoCE is reported as
equity in the SFP.
10/19/2020 Fundamentals of Accountancy, Business and Management 2 20Liabilities and Equity portion of the Statement of Financial Position

Friendly Convenience Store: Sole Proprietorship
Juana Dela Cruz is the owner of the Friendly Convenience Store:
The store was established on January 1, 2018. Juana deposited P
10,000.00 to a bank account in the name of Friendly Convenience Store.
She made three more deposits of P 2,500.00 each during the year form
her personal account. The store generated net income of P 35,670.00 in
2018. Juana regularly withdraws P 1,000.00 per month from the store’s
bank account for her personal expenses.
1. Determine the 2018 year-end balance of the Juana Dela Cruz,
Drawings account.
2. Prepare a Statement of Changes in Equity for the year ended
December 31, 2018.

A partnership is owned by two or more partners. Our
objective is to account for the equity of each partner.
Therefore, we need more than one capital account. As
a matter of fact, the number of capital accounts that
will be reported on the SoCE and the SFP is equal to
the number of partners. Similar to the capital account
used in sole proprietorships, each partner’s capital
account will track his contributions to the business,
his share in the net income and his drawings.

A Drawings account is also maintained for each partner.
The naming convention for both the capital and drawings
accounts is the same as in sole proprietorship.
Recall
How do we determine
the amount of net
income that will be
closed to each partner’s
capital account?
Accountants call this process “allocation
of net income.” Net income is allocated
based on the profit and loss sharing
agreement stipulated in the partnership
contract. Allocation of net income is
unique only to partnership.

PARTNERSHIP
The DEF Partnership was established in 2017. The partners, Diana,
Emina and Fanny have January 1, 2018 outstanding capital balances of P
25,600.00, P 43,800.00 and P 37,655.00 respectively. Diana contributed P
15,000.00 during 2018. Emina and Fanny also contributed P 10,000.00 each in
2018. The 2018 year end balances of each partner’s Drawings account are as
follows: Diana P 12,000.00, Emina P 15,000.00 and Fanny P 14,000.00.
The partnership reported 2018 net income of P 75,650.00. According to
the partnership agreement, the partner’s profit sharing ratio is 30%, 40% and
30% for Diana, Emina and Fanny.
Prepare the 2018 SoCE of DEF Partnership.

A corporation is owned by many stockholders that could
number to thousands. Moreover, the ease of transferring
ownership in corporations results in fast turnover of owners.
If we maintain one capital account for each stockholder, we
will end up with thousands of capital accounts. The fast
turnover of owners will mean accountants will be faced with
the voluminous and unending job of opening, transferring
and closing capital accounts. Mores so, we are faced with
the problem of allocating the corporation’s net income to
the thousands of fast moving shareholders.

The solution to these issues is simple. We will not
maintain a capital account for each shareholder. As a
result, there is no need to allocate net income to the
thousands of shareholders. We introduce three new
equity accounts, namely, capital stock, additional paid
in capital and retained earnings. We remain focused
on only three equity transactions – capital
contribution, drawings and accumulation of net
income.

The stockholders’ equity of a corporation is divided into
two parts, namely, paid in capital and retained earnings.
Paid-in capital is the most of contributions given or will be
given to the corporation in exchange for its common stocks.
The balance of Capital Stock reflects the par value of the
issued common shares. Par value is the minimum price by
which corporations can issue stocks to shareholders.
However, corporations generally issue stocks in exchange
for an amount greater than par. The excess of the issue
price over the par is reported as Additional Paid-In Capital.

The second half of the stockholders’ equity is the Retained
Earnings. This accounts reports the undistributed earnings
of the corporation. The balance of retained earnings is
computed as follows: net income minus net losses and
dividends from the date of incorporation up to the cut-off
or date of SFP. Dividends are distribution to stockholders,
similar to owners’ drawings in sole proprietorship and
partnership. Dividends are deducted from retained
earnings because dividends are taken from income
generated by the corporation.

CORPORATION
GHI Incorporated was established in 2018. The corporation
issued 10,000. P 10 par value shares of stock at an issue price of P
20 per share. Only July 15, 2019, the corporation issued 1,000 new
shares at an issue price of P 25 per share.
The corporation reported net income of P 56,785 and P 65,870 in
2018 and 2019, respectively. Dividends of P 2.15 per share were
declared and distributed to shareholders on February 1, 2019.
There were no dividends distributed on the first year of operations
of the corporation.
Prepare the 2019 Statement of Changes in Equity of GHI
Incorporated.

6/13/2017
Fundamentals of Accountancy, Business, and Management 2
Edmer M. Constantino
40

Chapter 3 statement of change in equity

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