Changing Equity From Non-Owner Sources

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Corporations receive equity from different sources and must record it to allow investors and analysts to understand how it affects the firm's financial results. A company's income statement presents most of its income and expenses in a fairly straightforward fashion, but certain non-owner transactions are recorded on the balance sheet. This makes it difficult for investors to understand all of the firm's financial activity if they only have access to the income statement.

Equity Sources

A corporation receives equity investments from investors and issues them shares of stock in return. These investors own a portion of the company for as long as they retain their shares of stock. A company can also receive equity from other sources that do not result in ownership. These non-owner sources of equity include capital donations and money the firm makes from investments in securities and foreign currency. A firm's total equity is shown in the stockholders' equity section at the bottom of its balance sheet.

The Income Statement

A corporation's income statement shows all income and expenses that come from the regular operations of the business. This is revenue from the firm's product and service sales, and all expenses incurred to produce those sales. The Financial Accounting Standards Board (FASB) has changed financial statement reporting guidance over the years, requiring firms to show income and expense from non-owner sources on the financial statements so that the financial statements represent the entire picture of the firm's financial status. These items are unrealized gains or losses that bypass net income, but must be recorded to add to net income and provide a view of comprehensive income for the corporation.

Other Comprehensive Income

FASB issued its Statement No. 130 on how firms should report certain types of non-owner income, classified as comprehensive income. Accountants record a firm's comprehensive income by making changes to total equity based on investment gains and losses, in an account labeled "Other Comprehensive Income." These amounts do not show on the firm's income statement; the adjustments are made directly to equity on the balance sheet. These non-owner equity changes consist of unrealized gain or loss adjustments on available-for-sale securities, translation adjustments on foreign currency, pension liability adjustments and market value fluctuations in futures contracts used as investment hedges.

Marking Securities to Market

Generally accepted accounting principles require firms to update the value of securities they hold over time so that analysts and investors can see the true value of the firm's investments. For example, if the firm buys 1,000 shares of stock in a company for $15 each, it records the investment value of $15,000 as of the purchase date. When it issues financial statements one month later, the stock price has dropped to $10 per share. The firm must update its financials to reflect this price change. An accountant makes an entry to decrease the other comprehensive income account and record the $5 per share drop in value as an unrealized loss on the stock.

References

About the Author

Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. She has worked as a financial writer and editor for several online finance and small business publications since 2011, including AZCentral.com's Small Business section, The Balance.com, Chron.com's Small Business section, and LegalBeagle.com. A Southern California native, Cynthia received her Bachelor of Science degree in finance and business economics from USC.

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