Owner's Equity of a Limited Company
The owner's equity of a limited company is the portion owned by the shareholders. It has three main components: share capital, reserves and retained earnings. This equity is shown at the lower part of the Statement of Financial Position.
Key idea
Total Equity = Share Capital + Reserves + Retained Earnings. Owner's equity shows the net worth of the company that belongs to the shareholders.
Components of Equity
- Share capital — the total paid-up capital of ordinary and preference shares.
- Reserves — profit kept for a specific purpose, for example a general reserve set aside to strengthen the company.
- Retained earnings — accumulated profit not yet distributed as dividends and carried forward to the next year.
Flow of Net Profit
Net profit after tax is added to the opening retained earnings. Dividends declared and any transfer to the general reserve are then deducted. The balance becomes the closing retained earnings carried to the Statement of Financial Position.
Example
Seri Bhd. has ordinary share capital of RM400,000, opening retained earnings of RM50,000 and net profit for the year of RM90,000. Dividends of RM30,000 are declared and RM20,000 is transferred to the general reserve.
| Opening retained earnings | 50,000 |
| Add: Net profit | 90,000 |
| Less: Dividends | (30,000) |
| Less: Transfer to general reserve | (20,000) |
| Closing retained earnings | 90,000 |
Total equity = 400,000 + 20,000 (general reserve) + 90,000 = RM510,000.
Reserves Presented in the Statement
Reserves are grouped into revenue reserves and capital reserves. A general reserve and retained earnings are revenue reserves, built up from ordinary trading profit and available to support future dividends. A capital reserve, such as a share premium, arises from sources other than normal trading and is not usually distributed as a cash dividend. In the Statement of Financial Position, share capital is listed first, followed by the reserves and the retained earnings, and their total is the equity that finances the company's net assets. A larger retained earnings figure shows that the company has ploughed profit back into the business rather than paying it all out.
Remember
Dividends are not an expense in the Profit and Loss Account; they are a distribution of profit deducted from retained earnings.