Stockholders' equity shows the amount of capital a company has received from investors in exchange for shares in the company. It also shows donated capital and the company's current and historical retained earnings. Stockholders' equity tells us the stake held in a company by equity investors. Various transactions affect stockholders' equity, some of which decrease the company's overall balance.
Retained earnings, including net income for the current year, make up part of stockholders' equity. Retained earnings reports the firm's cumulative net income from inception to the most recent accounting period. If a corporation operates at a loss, stockholders' equity decreases because the current year's net income reduces retained earnings.
Revenues and Assets
Revenues increase stockholders' equity through retained earnings, and expenses decrease it. This shows the direct connection between a company's income statement and balance sheet. Since stockholders' equity is equal to the sum of assets plus liabilities, an increase in assets causes an increase in stockholders' equity, while a decrease in assets or increase in liabilities causes a decrease in stockholders' equity.
When corporations pay dividends on stock, the payout activity decreases stockholders' equity. The dividend payments reduce retained earnings, which in turn reduces stockholders' equity. Firms also have a stockholders' equity account called treasury stock, which is a contra-account to stockholders' equity. The contra-account offsets the balance of stockholders' equity and reports stock re-purchases. A company may buy back its stock for several reasons. It may choose to distribute it to employees using a stock option plan, distribute it as a stock dividend, or repurchase it to defend against a hostile takeover bid. When the company repurchases stock, an accountant debits, or increases treasury stock and credits, or decreases cash. The result is a decrease in stockholders' equity.
Stockholders' equity may contain other items such other comprehensive income, or OCI. Items recorded in this account do not hit the income statement. They arrive at stockholders' equity through retained earnings; an accountant records them directly to the OCI account in stockholder's equity. These entries include gain or loss on available-for-sale securities, or foreign currency translation adjustment, and they may either increase or decrease stockholders' equity.
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