1.9: Changes in Stockholders' Equity

Any change in the Common Stock, Retained Earnings, or Cash Dividends accounts affects total stockholders’ equity.

Common Stock + Retained Earnings = Total Stockholders’ Equity

Stockholders’ equity increases due to additional stock investments or additional net income. It decreases due to a net loss or dividend payouts. Retained earnings increases when revenue accounts are closed out into it and decreases when expense accounts and cash dividends are closed out into it.

The following examples illustrate journal entries that can cause stockholders’ equity to change.

1. Stockholders’ equity before a business opens:

   Date	Account		Debit	Credit

   Common Stock + Retained Earnings = Total Stockholders’ Equity

   0 +0 =0

2. Stockholders’ equity after 30 stockholders invest $1,000 each, for a total of $30,000:

   Date	Account		Debit	Credit
   6/1	Cash		30,000
   	Common Stock			30,000

   Common Stock + Retained Earnings = Total Stockholders’ Equity

   30,000 + 0 = 30,000

   Each investor is now worth $1,000 in the business.

3. Stockholders’ equity after one month of operations in which Fees Earned is $65,000 and total expenses are $5,000 (so net income is $60,000):

   Date	Account		Debit	Credit
   6/30	Fees Earned		65,000
   	Retained Earnings			65,000
   6/30	Retained Earnings		5,000
   	ALL Expenses			5,000

   Common Stock + Retained Earnings = Total Stockholders’ Equity

   30,000 + 60,000 = 90,000

   Each investor is now worth $3,000 in the business.

   (The original $1,000 investment plus 1/30th of the $60,000 profit, or $2,000)

4. Stockholders’ equity after one month of operations and after each of the thirty investors receives a cash dividend payment of $500:

   Date	Account		Debit	Credit
   7/10	Retained Earnings		15,000
   	Cash Dividends			15,000

   Common Stock + Retained Earnings = Total Stockholders’ Equity

   30,000 + 45,000 = 75,000

   Each investor is now worth $2,500 in the business.

   (The original $1,000 plus $2,000 profit - $500 dividends paid out)

Stockholders’ equity can increase in two ways:

1. Owners invest in stock and Common Stock is credited and increases
2. Business generates net income and Retained Earnings is credited and increases

Stockholders’ equity can decrease in two ways:

1. Dividends are paid out and Retained Earnings is debited and decreases
2. Business experiences a loss and Retained Earnings is debited and decreases

The following calculation example shows how stockholders’ equity can change from the beginning to the end of an accounting period.

Beginning stockholders’ equity	12,000
+ Additional investments in stock	6,000
+ Net income (or – Net loss)	3,000
- Dividends	- 1,000
= Ending stockholders’ equity	\(\ \overline{20,000}\)

The calculation below is the same as the one above except that net income is instead presented as revenue minus expenses.

Beginning stockholders’ equity	12,000
+ Additional investments in stock	6,000
+ Revenue	5,000
- Expenses	-2,000
- Dividends	- 1,000
= Ending stockholders’ equity	\(\ \overline{20,000}\)

If net income is not given, you can solve for it algebraically using the calculations above. Assume net income is x in the first calculation above:

Beginning stockholders’ equity	12,000
+ Additional investments in stock	6,000
+ Net income (or – Net loss)	x
- Dividends	- 1,000
= Ending stockholders’ equity	\(\ \overline{20,000}\)

Beginning stockholders’ equity + Additional investments in stock + Net income - Dividends = Ending stockholders’ equity

12,000 + 6,000 + x – 1,000 = 20,000

x = 20,000 – 12,000 – 6,000 + 1,000

x = 3,000

The highlighted accounts are the new accounts you have learned.

LEARNING BY DOING

I learned how to drive a standard transmission car – using a stick shift – in San Francisco. My husband is an expert at this and was in the passenger seat as my instructor. In spite of the fact that he knew how to shift and clutch, and that he was telling me (rather loudly) what to do, I still rolled backward down a hill and over a motorcycle. I can drive a stick shift perfectly fine now, but it took lots of practice and stalling to get the feel of the process.

Accounting is a skills discipline; it is also something you learn by doing. Your instructor may be an expert who explains and demonstrates, but you will only truly understand the process with hands-on practice. You have to learn it by doing it to get the feel of the process. That is how you will become an expert yourself.

Topics – The basic accounting cycle	Fact	Journal Entry	Calculate Amount	Format
Business terminology	x
Net income			x
Types of accounts	x
Revenue accounts	x
Expense accounts	x
Income statement			x	x
Journal	x
Journalize revenue transactions for cash		x
Journalize expense transactions for cash		x
Post journal entries to the ledgers			x
Income statement			x	x
Journalize closing entries		x
Post closing entries to ledgers			x
Journalize and post revenue transactions on account		x	x
Journalize expense and post transactions on account		x	x
Asset accounts	x
Liability accounts	x
Journalize purchase of an asset for cash		x
Journalize purchase of an asset for a down payment and loan		x
Stockholders’ equity accounts	x
Journal entry for owner investment		x
Journal entry for dividends		x
Total stockholders’ equity			x
Accounting equation	x		x
Changes in stockholders’ equity			x
Retained earnings statement			x	x
Balance sheet			x	x
Financial statements connected	x		x
Accounting cycle	x