Shareholders' Equity and Accounting Changes

Shareholders' Equity and Corporate Structure

Net assets are defined as total assets minus total liabilities. Paid-in Capital and Retained Earnings are two of the three primary account classifications for Shareholders' Equity (SE).

Disadvantages of the Corporate Form

• Paperwork is expensive.
• Double taxation.

Advantages of the Corporate Form

• The corporation is a separate legal entity—separate and distinct from its owners.
• Ownership interest is easily transferred.
• Shareholders do not have a mutual agency relationship.
• Limited liability: Owners are not personally liable for the debts of the corporation.
• Ease of raising capital.

Articles of Incorporation

Corporations have articles of incorporation (corporate charter). It describes the nature of the firm’s business activities, the shares to be issued, and the composition of the initial board of directors. The Board of Directors establishes corporate policies and appoints the individuals who manage the corporation.

Common Stock and Equity Reporting

Common Stock = Number of Shares × Par Value

Accumulated Other Comprehensive Income (AOCI) is reported on the balance sheet as part of the Shareholders' Equity section.

Outstanding Common Stock

Outstanding shares refer to a company's stock currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company's officers and insiders. Outstanding shares are shown on a company's balance sheet under the heading “Capital Stock.”

Restricted Stock Units and Compensation

A Restricted Stock Unit (RSU) is compensation offered by an employer to an employee in the form of company stock. The employee does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a specific duration.

• Any compensation associated with RSUs is allocated to an expense over the service period.
• The compensation associated with executive stock options is estimated at par value.

Accounting Changes and Error Corrections

Retrospective Changes

• Change in accounting principle: A change in a method used, such as using a different depreciation method or switching from LIFO to FIFO.
• Error correction.
• Change in reporting entity.

Prospective Changes

• Change in accounting estimate.

Reporting and Communication

Under the use of the retrospective approach, prior year financial statements are revised to reflect the change in new principles. Regardless of the type of accounting change, the most important requirement is to communicate the change. We no longer use the cumulative effect; it does not exist anymore.