Shareholders' Equity

Despite the simple definition initially provided, the Conceptual Framework does expand on the concept of equity by explaining that funds contributed by shareholders, retained earnings, and other reserves may require separate disclosures. The reasons given for a more detailed disclosure include the objective of providing information about legal restrictions on the distribution of equity that may be useful to investors for decision-making purposes, and the need to disclose the different legal rights that may attach to the various types of equity interests. The Conceptual Framework also notes that although, by definition, equity is affected by the measurement of assets and liabilities, the amount of equity reported would only coincidentally be equal to the current market value of a company. This is an important point, as it highlights one of the limitations of financial reporting: that financial statements by themselves cannot tell an investor what a company is worth.

The components of equity will vary from business to business and will be affected by the type of legal structure adopted by the business. This chapter will focus on the accounting used in the most common type of business organization – the corporation. Accounting and disclosure for other types of entities, such as proprietorships and partnerships, will be different. However, the same basic principles apply to those types of entities as well. Let's now look at the various components of equity, using the classification from the Conceptual Framework: funds contributed by shareholders, retained earnings, and reserves.