FUNDAMENTALS OF ACCOUNTANCY, BUSINESS, AND MANAGEMENT 2

CHAPTER 3: STATEMENT OF CHANGES IN EQUITY

Statement of Changes in Equity is the financial statements form a set of interrelated

reports. SFP is a report on the company's assets, liabilities, and equity. The equity component
of the SFP shows the claim of the owners on the company's assets. This is the reason why
equity accounts are of particular interest to the readers of the financial statements. The SoCE is
prepared to meet the requirements of the readers to understand the transactions that caused
the movements in equity accounts.

Forms of Business Organization

The business organization determines the presentation of the SOCE and equity portion
of the SFP. There are three basic forms of business organizations:

1. sole proprietorship
2. Partnership
3. Corporation

They differ in terms of number of owners, legal personality of the business, and ease of
transferability of ownership.

Sole proprietorship is the simplest form of a 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.

Partnership is a business owned by two or more owners called partners. They pool their
resources 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 contract of partnership specifically, the partners'
profit and loss sharing arrangements.

A partnership has a legal personality separate from its owners. It is taxed separately
from the partners except for those formed for the practice of the profession of the partners (Le.
lawyers, accountants, etc.). However, the claims of the partnership creditors may ex tend to the
partners' personal assets.

Corporation is the most complex form of business organization. A corporation is owned

by many owners called stockholders or shareholders. Ownership is divided into common stocks
or shares of stocks. One shareholder can own many stocks. Shareholders are not normally
involved in the day to day operations of the corporation. Rather, owners set up policies for the
management of the corporation. In policy setting, each stock is normally entitled to one vote. A
stockholder that owns 1,000 stocks has 1,000 votes. Therefore, the stockholder that owns 50%
+1 of the total stock outstanding can control the corporation. Rules that govern the management
of the corporation are written in the Articles of Incorporation and By-Laws.

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.

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One of the characteristics of a corporation is the separation of ownership and

management. Shareholders invest their funds and the corporation 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.

Preparation of Statement of Changes in Equity

The form of business organization determines the equity accounts reported on the
financial statements. 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.

Sole Proprietorship

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.

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.

Net income is closed to the capital account, because:

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.

Partnership

A partnership is owned by two or more partners. Its objective is to account for the equity
of each partner. Therefore, it needs 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.

The amount of net income that will be closed to each partner's capital account is called
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.

Corporation

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 one capital account for each stockholder will maintain, it 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. More so, we are faced

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with the problem of allocating the corporation's net income to the thousands of fast moving
shareholders.

The stockholders' equity of a corporation is divided into two parts, namely, paid in capital
and retained earnings. Paid-in capital is the amount of contributions given or will be given to
the corporation in exchange for its common stocks. Paid-in capital is composed of capital stock
and additional paid-in capital. 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 account
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 distributions to stockholders, similar to owners'
drawings in sole proprietorship and partnerships. Dividends are deducted from retained
earnings because dividends are taken from income generated by the corporation.

Equity accounts have normal credit balances. All three equity accounts namely, capital
stock, additional paid-in capital and retained earnings all have normal credit balances

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