A trial balance carries a retained earnings figure whose meaning depends on closing status and direct postings. The preparer checks both before building the statement of changes in equity, which bridges the January 1 balance to the December 31 balance one movement at a time.
The statement of changes in equity reconciles the beginning balance of every equity class to its ending balance through the movements of the period. Under U.S. generally accepted accounting principles (GAAP), an entity presents that reconciliation as a separate statement or in the notes, showing changes in both amounts and share counts.
Each column is one equity class, and the right-hand column is total equity:
- Preferred stock: par or stated value of equity-classified preferred shares issued.
- Common stock: par or stated value of common shares issued, including shares later reacquired into treasury.
- Additional paid-in capital (APIC): amounts received above par on issuance, plus credits from treasury reissues, stock dividends and share-based compensation.
- Retained earnings: accumulated earnings after distributions, retrospective adjustments and other applicable direct movements.
Common mistakes
- Beginning balance from the trial balance. Common stock on the trial balance is $300,000, the ending figure; a preparer who starts the row there shows the $50,000 issuance twice and ends at $350,000.
- Material prior-year error through net income. Charging the $20,000 Year 1 depreciation to Year 2 cuts net income to $164,000 and skips the tax effect; the correct row is a $15,000 prior-period adjustment.
- Small stock dividend at par. Capitalizing the 10 percent dividend at par moves only $28,000 out of retained earnings instead of the $89,600 fair value.
Bottom line
- The statement rolls every equity class from its beginning balance through the period's movements to its ending balance, and the ending row must agree to the balance sheet equity section.
- Check closing status and direct postings before treating trial-balance retained earnings as an opening balance. Beginning equity comes from the prior-year statement; ending less beginning gives net change, while supporting records identify each movement.
- Common retained-earnings movements include income, cash, property and stock distributions, retrospective adjustments, and applicable treasury or retirement transactions. Allocate consolidated income and OCI between parent equity and noncontrolling interests.
- A small stock dividend (less than 20 to 25 percent) is capitalized at declaration-date fair value and a large one (25 percent or more) at par; total equity is unchanged either way.
Exam shortcut
Check closing status, direct postings and classification before building the opening row. Use declaration-date fair value for a small stock dividend and compare source amounts with ledger amounts on the same tax basis. Reconcile every movement and equity column, then prove issued shares less treasury shares equals outstanding shares.
The full lesson (about 5,933 words, 40 min read) adds 5 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- I.A4
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