According to the Conceptual Framework for Financial Reporting “equity is the residual interest in the assets of the entity after deducting all its liabilities”. Unlike a sole trader’s or partnership’s equity, the equity of a company consists of a number of categories such as:
- Share capital
- Share premium
- Retained earnings
- Other reserves
- Revaluation reserves
- Foreign exchange reserves
- Capital redemption reserves
- and so on…
These different categories of equity are required in order to comply with the requirements of the law (i.e. the Companies Act) as well as financial reporting standards and because the different reserves can help users keep track of how and why a company’s reserves are changing from one financial period to another.
The Statement of Changes in Equity
The Statement of Changes in Equity describes how the value of each class, or category, of equity has changed over a financial period. Like other statements, information for both the current and previous financial period will be provided. In the case of this statement each year is usually shown as a separate table (this is due to the difficulty in finding a layout that would permit both periods’ figures shown side by side).
Illustration of how a Statement of Changes in Equity is laid out
Each category of equity that exists at any point during the financial period is normally shown in a separate column (though please note the alternative layout show below) together with a column to record the total of all equity.
The entries in the table should show the values of the categories of equity at the start and end of the financial period and also explain how they have changed.
The above Statement tells us that shares were issued during the year, resulting in the increases in Share Capital and Share Premium. It also tells us that the company made a Profit for the year of £413,000 which was added to its Retained Earnings and from which dividends of £300,000 were declared. In addition, it tells us that the Statement of Profit or Loss and Other Comprehensive Income included a gain on revaluation of £266,000 which was added to the Revaluation Reserve. Finally, it tells us that there were no changes to the company’s Capital Redemption Reserve during the year.
Some companies’ equity consists of many different categories or types of equity. Where the number makes it impractical to display on all of them on a single page, companies will merge some of the categories of equity together. This is illustrated below where the Revaluation Reserve and Capital Redemption Reserve of Bear plc have been merged into Other Reserves.
Where a company has merged some of its reserves together in the Statement of Changes in Equity it will include a breakdown in the notes to the financial statements so that no information is lost.
Dividends and the statement of changes in equity
Dividends are distributions made by the company to its shareholders and are paid from a company’s distributable reserves, which are basically, a company’s retained earnings. It is illegal for a company to declare a dividend that is larger than its distributable reserves, so company directors should take great care to ensure that this does not happen.
These types of dividends are approved and declared by the Directors of a company. They can be declared at any time during the year and should be paid by the company when they are declared. This means that interim dividends should be included in the company’s Statement of Changes in Equity when they are declared/paid.
Once the financial statements for a year are finalized are approved for issue by the Board of Directors they are normally then presented to the Shareholders at a General Meeting of the Company.
At this meeting of the company, the shareholders are often asked to vote on whether or not a final dividend for the financial period should be approved. The Directors propose the amount of the dividend but it is the Shareholders who make the final decision and may reject it if they wish.
It is therefore not known at the year-end whether a final dividend for the financial period will be authorized and as a result it cannot be included as a distribution in the Statement of Changes in Equity for the year (though any final dividend authorized during the period for the previous year will be included in the Statement).
Atalanta Ltd has a year-end of 31st May. In the year ended 31/05/2019 the directors approved and declared interim dividends of £50,000. A final dividend of £80,000 for the year ended 31/05/2019 was proposed by the directors and later approved by the shareholders on 31st July 2019 and was paid on 14/08/2019.
Then in the year ended 31/05/2020, the directors approved and paid interim dividends of £75,000. A final dividend of £100,000 for the year ended 31/05/2020 was proposed by the directors and later approved by the shareholders on 31/08/2020 and was paid on 14/09/2020,
The dividends that would be recorded in Atalanta Ltd’s Statement of Changes in Equity for the year ended 31/05/2020 are as follows:
- The interim dividends for the year ended 31/05/2020 of £75,000
- The final dividend for the year ended 31/05/2019 of £80,000 (as this was declared and paid in this year)
- The total for the year was £155,000
The proposed final dividend for the year ended 31/05/2020 would not be included in either the Statement of Changes in Equity or the Statement of Cash Flows for the year ended 31/05/2020 but details about the proposed dividend would be included in the Notes to the Financial Statements. This dividend would however, be recorded in the Statements for the next year, i.e. the year ended 31/05/2021.