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Level I CFA: FRA Understanding Balance Sheets-Lecture 3 - YouTube
Channel: IFT
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coming now to the equity segment of the
[3]
balance sheet
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equity is the owner's residual claim on
[7]
a company's assets
[9]
after subtracting its liabilities
[12]
sometimes this is also called
[13]
net assets and here are the various
[16]
components
[17]
of equity you will notice that with
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equity there are no
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rules defining how equity is valued
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because
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equity is simply the difference between
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assets and liabilities
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we will study rules for measuring
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different kinds of assets
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we will study rules for measuring
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different kinds of liabilities
[36]
and equity is simply the differential
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however with equity we need to
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understand the different
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categories and those categories at least
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the major ones
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are shown over here contributed capital
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is the money that has
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actually been contributed by the owners
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either at the start of the company or
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during the life of the company so this
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is money that is coming from
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outside the company given by owners
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to the company and obviously owners then
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have a ownership claim
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based on the money that they have
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contributed to the
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company this is called common stock or
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issued capital it may have a par value
[80]
or stated value
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a company needs to disclose the number
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of shares which are authorized
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issued and outstanding when a company
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is created it has to state
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how many shares are authorized let's say
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that a company
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is started and the number of shares
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authorized is 100 million this means
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that the company has the authorization
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to
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issue up to 100 million shares it does
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not mean that
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100 million shares will be issued
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immediately
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let's say that out of this 100 million
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the company initially
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issues 40 million shares so that is the
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amount
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of shares that have been issued notice
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that
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issued shares will have to be less than
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the number of shares
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authorized a year later a company might
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buy back 10 million shares
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this buy-back of shares is called
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a treasury stock operation this is
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referred to
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as treasury shares so we buy back
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10 million treasury shares and what we
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are then left with
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is 30 million shares outstanding so
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shares outstanding
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is 30 million earlier when we talked
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about
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earnings per share calculation we were
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actually calculating earnings per
[168]
outstanding shares so the outstanding
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shares are the shares that are being
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traded and that is the
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critical item out of these three
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retained earnings refers to the earnings
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that a company has generated which have
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not been paid out as dividends earnings
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that have not been paid out as dividends
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are retained within the company
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and we've seen several examples up till
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now
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a company might generate 100 million in
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profits
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of which it might pay out 20 million as
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dividends and retain 80 million
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this 80 million would be called retained
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earnings
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next year a company might retain another
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80 million which would create a total of
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160 million worth
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of retained earnings the reason this is
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called equity is that the 100 million
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really belongs to shareholders and
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rather than take it out
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they are putting it back in the company
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so they are plowing the money back or
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reinvesting the money or retaining the
[235]
money
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hence it is considered part of equity
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accumulated other comprehensive income
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we have already talked about this
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there are items such as available for
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sale
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securities where the gains the
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unrealized
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gains on afs are not passed through the
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income statement they directly increase
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equity
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and their increase is reflected in the
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component of equity called
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other comprehensive income there are
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three other items
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that cause oci to go up and i have asked
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you to
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memorize those three items in a earlier
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reading
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non-controlling interest is the minority
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interest
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if you own a company let's say you have
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80 ownership then there is this other
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party which has 20 percent ownership
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that 20 ownership is shown as the
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non-controlling interest or
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minority interest that is also equity
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and finally preferred shares or
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preference shares
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these are classified as equity
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or financial liabilities depending
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on the characteristics now if we have
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preferred shares that are redeemable
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or that are going to be redeemed at a
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certain price
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by a certain date then the preferred
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shares have to be classified as
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liabilities on the other hand perpetual
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preferred shares
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are generally classified as equity
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to understand the major components of
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equity let's
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look at this simple example
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at the start of year one owners
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contribute
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100 so that is the issued
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capital among other assets the company
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purchases
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financial assets categorized as afs
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worth 100 so
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during year 1 the net income is 20 which
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is retained
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the value of financial assets goes up to
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12. during year 2 there is a treasury
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stock operation worth
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20 net income is 40 which is retained
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financial assets go up to 15. you need
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to show the relevant equity components
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at the end of year 1 and end of year 2.
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pause the video before you look at the
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solution
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here is what you should come up with the
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issued capital at the start
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and end of year one is 100 000.
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during year one there was no treasury
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stock operation
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the retained earnings for year one
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are 20 because we said the entire net
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income of 20
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is retained accumulated other
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comprehensive income so
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started from zero and uh afs
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started at 10 went up to 12. so the
[420]
increase
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is two oci therefore
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is two total equity at the end of year
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one
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is a hundred and twenty two then for end
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of year two
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issued capital stays the same but in
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year two
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we have a treasury stock operation worth
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30. so this is -30 a treasury stock
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operation is
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always a negative it's reducing the
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number of
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shares outstanding accumulated retained
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earnings goes up to 60 because
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we started year two at 20
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and then in year two we have
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earnings of 40 and this entire amount is
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retained so the accumulated retained
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earnings
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equals 60. other comprehensive income
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for year two
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is three because we went from 12 to 15
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so the oci for year 2
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is 3 the accumulated oci
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is 2 plus 3 which is
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5. the total equity at the end of year 2
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is simply a
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sum of these items and that is 135.
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the statement of changes in equity
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presents information about the increases
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or decreases
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in a company's equity over a period
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ifrs requires the following information
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in the statement of changes in equity
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so you can read this i think u.s gaap is
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a little easier to understand
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u.s gaap requirement is for companies to
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provide an analysis of changes
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in each component of equity as shown in
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the balance sheet
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and to understand this let's look at
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an excerpt from apple's consolidated
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changes
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in shareholders equity you don't need to
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understand every detail here
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but you should try to get the main point
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this first row represents the start of
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the period
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at the start of the period the common
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stock
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is 7177
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this represents the amount that has been
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contributed by
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owners the retained earnings
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equals fifteen thousand one hundred and
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twenty nine this is the total amount of
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earnings that have been retained up till
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this date the accumulated
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oci on this date is minus nine
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and you add up these items you get total
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shareholders equity at the start equal
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to
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22 to nine 7
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the bottom represents the situation at
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the
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end of the period the common stock
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is 8210
[600]
retained earnings 2 3
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3 5 3 which is a much larger number
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compared to the
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start of the period oci went up to
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[Music]
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77 this is actually accumulated oci
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and note that the total shareholders
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equity
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went up from 22 000 to
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approximately 31 640.
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now where did this change come from
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what you can notice from the bottom line
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is that a significant contribution came
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from
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retained earnings which is good but let
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us evaluate this a little more
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when you look at common stock the
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company has
[646]
issued new stock the company has
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some stock based compensation and then
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there
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is common stock issued under stock plans
[656]
new shares are issued which is why this
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column is going up
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the most interesting item here is that
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retained earnings are going up a lot
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because of this high
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net income and this shows that the
[673]
company
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is doing well so there is
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a major element right here with oci
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if you recall i asked you to remember
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the four items
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that contribute to oci and you
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see them over here the one that you need
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to understand
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is changes in unrealized
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loss on afs securities so notice
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that in this period there must have been
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substantial gains
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on the afs front which is why
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the oci is going from negative
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territory to substantially positive
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territory
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other oci elements also had a
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contribution but
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a negative contribution now there are a
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few other minor items here
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but i don't think you really need to get
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into the details
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the key points have been addressed
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