Owners’ equity is the portion of a company’s balance sheet which represents the shareholders’ claim on the assets of the business.
Owner’s equity is calculated by subtracting liabilities from assets.
The three basic components of owners’ equity are (1) capital contributed from shareholders, (2) retained earnings, and (3) treasury stock.
Capital contributed from shareholders is the monetary capital provided by shareholders in exchange for equity shares in the company. Retained earnings are the company’s profits which have been retained after dividends have been paid to shareholders. Treasury stock is the net amount of stock shares which the company has repurchased from shareholders. Treasury stock represents a decrease in the number of outstanding shares and is accounted for as a reduction in owners’ equity.
As an example of the owners’ equity account, consider a company which raises $10 million in equity capital. The company uses these proceeds to purchase assets necessary to operate the business. The company has no debt and no liabilities. In the company’s first year in business, the company has net income of $800,000 and pays $200,000 in dividends to shareholders. The company repurchases $500,000 worth of stock shares. What is the owners’ equity at the end of the year?
To find owners’ equity, we first calculate retained earnings. Net income was $800,000 and dividends were $200,000, so retained earnings were $600,000. We add the $600,000 in retained earnings to the $10 million in contributed capital and subtract the $500,000 increase in treasury stock. Owners’ equity at the end of the year is thus $10.1 million.