8. Retained Earnings vs Shareholder's Equity

Here we're gonna take a look at one thing that you probably know pretty well and one thing you might not have heard of yet. So we're gonna look at the statement of retained earnings versus the statement of shareholders' equity. And hopefully you're pretty good on retained earnings, but if you have some questions on what the heck the statement of shareholders' equity is, that's kinda what we're gonna be talking about. So as a quick recap, let's talk about retained earnings. Statement of retained earnings says you take your beginning retained earnings, you add in your net income, you take out your dividends, and that gives you your ending retained earnings.

And so what you're looking for when you do the statement of retained earnings is, how did retained earnings change over the year? And so triangle, delta, that means change. So the change between beginning retained earnings and ending retained earnings is net income minus dividends. That's how you get from beginning to end. That's the change in retained earnings, okay? We've already gone over all this. This should be old news to you. Now, shareholders' equity, what in the world would a statement of shareholders' equity look like? Let's recap. Shareholders' equity is part of the accounting equation, and if you'll recall, it's made up of two parts itself.

It's made up of contributed capital plus retained earnings. So if the statement of retained earnings is beginning retained earnings plus change in retained earnings equals ending retained earnings, that makes enough sense. So let's make up a statement of shareholders' equity. Let's call it beginning shareholders' equity plus the change in shareholders' equity gives us ending shareholders' equity, right? This isn't rocket science. To get from the beginning to the end, you add in the change. It's not rocket science, and it's also not super helpful, because what is the change? Over here we said the change is net income minus dividends. We know what the change is there, but I haven't told you how to figure this out yet.

So this is kinda step one. We know that we wanna go from beginning to end, and we do that by adding in the change. Now, shareholders' equity is made up of contributed capital and retained earnings, isn't it? So what if we said this? What if from here we go, beginning shareholders' equity plus the change in contributed capital plus the change in retained earnings gives us ending shareholders' equity. So do you see how we did that? Just like shareholders' equity is broken out into these two parts, the change in shareholders' equity is broken out into the change in contributed capital and the change in retained earnings.

Okay, so we're getting a little bit closer, because look here, change in retained earnings. Well, we've already defined that. We know what that is. The way that retained earnings changes is by adding net income and taking out dividends. So we defined that already. So we can go a step further and say, beginning shareholders' equity plus the change in contributed capital plus the change in retained earnings, which we know is equal to net income minus dividends. Do you see how we're deriving this formula or this statement all on our own here? So we started out by saying, beginning plus some change, I don't know what change, equals end.

And then we said, well, this change has two parts, so let's break it up into two parts. And we say, oh, I know what that is. Let me plug those in. So this change in retained earnings becomes these two things right here.

So now all we're left with is the change in contributed capital. And if you remember, contributed capital talks about stock. It's when we issue new stock. So this change, the change in contributed capital, just means new stock. So now we have a legitimate statement. We have beginning shareholders' equity plus any new stock plus any net income minus any dividends equals ending shareholders' equity. So this is what some of your teachers may call the statement of shareholders' equity. And don't feel like you have to memorize or don't get scared by the statement of shareholders' equity as an entirely new statement, because truly it's not. You can make it up just like we did as long as you understand what shareholders' equity actually is.

So if shareholders' equity is split up into two parts, the statement of shareholders' equity should also be split up into two parts. So we have contributed capital and retained earnings. Where you're gonna see this is if the problem says something like, "New stock was issued." This new stock was issued, that's your giveaway that you need to be using the statement of shareholders' equity. And you know, I don't even really like the statement of shareholders' equity because I don't think it's helpful. I think it's kind of silly. So you have a statement of retained earnings, right? This one is helpful because you need to know what your ending retained earnings are.

And for contributed capital, you just have beginning contributed capital plus new stock equals ending contributed capital. I mean, that's all it really is to get to contributed capital. And shareholders' equity is just ending retained earnings plus ending contributed capital.

So I don't think a statement of shareholders' equity makes a whole lot of sense in most cases, but it doesn't matter what I think. What matters is that you understand what it is. And this is all it is. It's the statement of retained earnings, and then you add in the new stock because you need to find out the change in contributed capital.

So you're trying to find the change. You decide the change is made up of two changes. This retained earnings change is made up of net income and dividends. The contributed capital change is just made up of new stock. So now we've arrived at our statement.