Level 1 CFA® Exam:
Equity & Statement of Changes in Equity

Last updated: October 11, 2022

Defining Equity for Level 1 CFA Candidates

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In this section, we will define equity and its components as reported on the balance sheet. We will also explain how to report changes in equity within the financial statements.

Equity (aka. shareholders’ equity) is the owners’ residual interest in the assets of the company and it represents the excess of the company’s assets over liabilities.

Put simply, equity is the owners’ interest in the company, i.e., share capital they have invested in, as well as the accumulated proceeds that the company has generated – called retained earnings – which also belong to the owners.

Components of Equity

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We distinguish the following 6 components of equity (company’s capital) reported in the financial statement:

  1. Capital contributed by owners (aka. common stock or issued capital) – represents the money invested in the company by its owners who own common shares issued by the company. Financial reporting standards usually focus on the disclosure requirements – par value and the number of authorized, issued, and outstanding shares should be presented in the balance sheet.
  2. Preferred shares – a specific type of shares that usually provides its owners with the rights superior to a common share. The superiority might be manifested in the form of (i) recurring dividends paid out to the owner, (ii) seniority with regards to the liquidation proceeds, or (iii) specifically defined non-standard benefits. Depending on their characteristics, preferred shares may be classified as equity or financial liabilities.
  3. Treasury shares (aka. treasury stock or own shares repurchased) – own shares which have been repurchased by the company and have not been canceled. It is important to note that, unlike common stock, treasury shares do not represent the ownership right and do not entitle to any dividends. There are multiple reasons why companies might want to hold their shares, e.g., to remunerate their employees with stock, boost or maintain the price of the stock (if listed) as a substitute for dividend, or offset dilution.
  4. Retained earnings – accumulated profit generated by the company during its lifetime that has not been distributed to the shareholders.
  5. Accumulated other comprehensive income – this position presents the total accumulated other comprehensive income which is driven mainly by the accounting treatment of balance sheet or income statement positions. As we previously discussed, companies have the right to choose accounting methods for certain assets and liabilities, which may result in the creation of other comprehensive income, e.g., the decision to value financial instruments using Fair Value through other comprehensive income.
  6. Non-controlling interest (NCI) (aka. minority interest) – represents the value of the company’s subsidiaries’ equity in hands of the minority owners who cannot drive the strategic decision-making process (usually such stakeholders own less than 10% of the subsidiary’s net assets).

1-5 above constitute equity attributable to owners & sum up into total owner’s equity, 6 – constitutes equity attributable to minority investors (non-controlling interests).

Level 1 CFA Exam Takeaways for Equity & Statement of Changes in Equity

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  1. Equity, which is the residual amount that is left after deducting the liabilities from assets (E=A-L), demonstrates the value attributable to the owners of the company.
  2. Equity reported in the balance sheet is usually split into capital contributed by owners, preferred shares, treasury shares, retained earnings, accumulated other comprehensive income, and non-controlling interest.
  3. Statement of changes in equity allows the users of the financial statement to better understand how the equity changed during the reporting period and identify new stock issuances, dividend payments, share buybacks, and changes derived from accumulating retained earnings in the company.