If you take a company's assets and subtract everything the company owes or is obligated to pay (the liabilities), the remainder, if any, is the equity of the company. It is that portion of the assets that the shareholders own.
Assets are funded by two things: debt and equity. Equity is generated by purchase of an ownership stake directly from the company or by contributing cash to the company. It is also generated by the company generating net income and retaining it for investment back into itself.
Within the equity portion of the balance sheet, there are several items:
- Retained earnings
- Common stock at par value
- Excess contributions
- Preferred shares
- Treasury stock
- Other comprehensive income
That portion of net income which is not paid out to shareholders as a dividend is kept by the company and reinvested, hopefully to generate even more net income in the future. If the company has been running losses, then this will be a retained deficit instead.
A company's articles of incorporation state the value of the company's common shares. This is usually in the $1 range or less. This is an arbitrary number, not related to the current share price. This number is often referred to as the par value of the shares.
When a company sells shares of itself, part of the proceeds go into the Common Stock at Par account (the $1 or whatever) and the remainder is recorded here. It is the price paid to the company for shares of itself above and beyond par value.
The value of preferred shares sold to investors. These are shares that act more like bonds than like common stock.
When the company buys back shares of itself on the open market, it records the amount spent in this account. This will be a negative balance and it reduces the total amount of equity.
Other comprehensive income
This is where various gains or losses are recorded that do not belong on the income statement, according to FAS130. These include unrealized gains or losses on securities held for sale, gains or losses on derivatives held as cash flow hedges, gains or losses from converting operations of subsidiaries recorded in foreign currency into the company's reporting currency and other special items. This is usually an accumulated total.
One of the four financial statements which records the amounts and sources of changes to the equity portion of the balance sheet.
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