 In this discussion, we will discuss the discussion question of describe the equity section of corporate financial statements. So when considering an essay question like this or a discussion question like this, we may want to approach it by comparing and contrasting the equity section of a corporation to other entities such as a partnership or sole proprietor. Note that when we see something like this, clearly the objective here is to focus in on those areas that are different between business entities. As we do that, recall and remember that much of the business entities are going to be much of the same, whether we're a sole proprietor, partnership, corporation, objective, generate revenue, objective, get that revenue in the form of distributions in some way to the owners to better the lives of the owners. So normal business transactions will be the same. We're going to keep the business separate from the owners in all types of business entities. When we look at the different entities, though, of course, we want to know what's going to differ so that we know which entity would be best under certain types of circumstances. That's why we focus on the differences. Here we're going to be focusing on an area of the financial statements that will differ, that being the equity section. Why? Because the format of ownership is what's different and that's being represented in the equity section, the equity section representing what is owed to the owner in a sense. In other words, all equity sections as a whole we can think of as much the same, meaning if we look at the accounting equation, assets equal liabilities plus equity, otherwise formatted as assets minus liabilities equals equity, means that equity as a whole, whether sole proprietor, partnership, corporation, is the net value of the company. It's the assets minus the liabilities. It's the book value, the worth, the value of the company. You can also think of it as what the company is kind of owed not to a third party but to the owners, whoever those owners are, whether it be one person, partnership or stockholders. It's all kind of the same thing in that sense from a fundamental total sense. So in other words, if all the corporation was shares were owned by one person, it would be just one person that owns all the shares. One shareholder would be similar to kind of a sole proprietor in that case because assets minus liabilities would be what is owed to the owner. If we were to liquidate any type of business, we would sell off the assets, we would pay off the liabilities. The difference then would be given to the owners, whoever they are, which in essence again in total is the equity section. What differs between a sole proprietorship, partnership and corporation? Well, the sole proprietorship and partnership, the ownership is going to be broken out by capital accounts. And the capital accounts for like a partnership will differ because they don't have to be the same. But for a corporation, on the other hand, we're not going to list all the owners of a corporation. We don't have to do that, which is great because if you have a lot of partners in a partnership, the capital count tracking can be very cumbersome. With a corporation, we can have a lot of people that are owners of the corporation who own stock within the corporation, but we don't list out each individual owner, that's the beauty of the corporation. What do we do instead on the corporate financial statements? We just list out the breaking out of the equity section between how much was invested and how much has been accumulated over time. So in other words, if we look at a partnership, we have to list out the equity section in terms of how much of the book value of the partnership in essence is owed to each partner. That's the value of their capital account or the amount of their capital account. With a corporation, all the stocks are the same. So how much people own in the corporation is not determined by an individual capital account or not tracked through an individual capital account, but through the number of shares that they have. So we don't need to list them out. What we do instead is we still break it out, but we break it out between the amount of investment, which would be the common stock that was purchased. So the common stock and the additional paid in capital versus the amount of earnings that have happened over the life, less any draws, any dividends that have been given, that being called retained earnings. So those are the two primary components to the equity section that we have. Why do we do that? Well, if we give a distribution from a corporation, we want to be able to track whether it came from the initial investment, which we don't typically want to do, or if it came from the earnings that were generated over and above the initial investment, that being in retained earnings. So retained earnings is where we're going to take any kind of dividends from. It's going to come out of retained earnings. We're not going to take it out of the common stock amount, which is basically the initial investment that was put into the company. So we need to keep those kind of things separate, or it's helpful to keep those two components of the equity section separate. So those are going to be the major two components. Now, if we go a little bit deeper in terms of the common stock side, we typically have common stock and additional paid in capital, which is a little confusing. Why? Because the common stock, we often have a par value and it's useful for us to really standardize that common stock by saying that we're going to issue all stock for that purposes of that common stock at a stated par value. Now, when we actually sell it, we're going to sell it for the market value, which will differ depending on when we sell the stock. But we're going to record it on the books at the par value. And that means that that number for the common stock will always be uniform and have the same ratio to the number of stocks. So that'll be a nice even number for us. We'll know exactly what that number represents in terms of the number of stocks and the par value. And then we're going to have the additional paid in capital, which represents any kind of investment that was given to the company over and above the par value. So the market value minus the par value times the number of stocks if it was only one time. But that number will differ. There's no kind of uniformity to the additional paid in capital because when we sell stocks at different point in time, we will get, you know, we'll sell for whatever we can. We're going to sell it for over the par value typically. The par value typically being a fairly low standard number compared to the market value. So the additional paid in capital plus the common stock will represent how much was paid for the ownership of the company in the form of stock. That's kind of like the initial investment for a sole proprietor would be our initial investment we put into the capital account or for a partnership, the initial investment we put into the partners capital accounts. Okay, so that's going to be that. Then the retained earnings is kind of like when we close out the cash. It's the same as when we close out the capital accounts for a sole proprietor. When we close out the temporary accounts, the income statement and the draws revenue expense and draws to the capital account for a partnership or sole proprietor. For a corporation, we're not going to close revenue out to the common stock. We're going to close it out to what we call retained earnings. So the temporary accounts at the end of the time period will be closed out to retained earnings for a corporation. Those are the two primary components you want to keep in mind now. There's other kind of components in the equity section that really will only be there. We have a larger kind of company that can really kind of muddy the waters. And one of those things could be Treasury stock and preferred stock. So preferred stock is going to be another type of stock ownership that doesn't usually have voting rights, but has a preference or has a benefit of being paid first typically when dividends are distributed or when liquidation happens. So we could have the same type of idea for preferred stock, which means we have it on the books and we could have an additional paid in capital for preferred stock for the initial investment of the preferred stock when people purchase the preferred stock. And then we've got the Treasury stock, which is another area which is a bit confusing, which would mean that the corporation would purchase back their own stock. So if we issued stock, if we were a big company, if we were Apple or something, we issued stock in the stock market, which is now trading between other people in the stock market. And then we went back in at some future point and bought back our own stock. We would credit cash and debit Treasury stock. And the confusing thing about Treasury stock is it represents, it's on the books in the equity section, but it's a debit balance. And therefore because equity has a credit normal balance, it's actually decreasing the total equity section. So those are some other kind of components. One of the major things you want to get though when thinking about the equity section is the fact that we have the common stock portion, which will typically be the common stock and the additional paid in capital, the initial investment from the owner to purchase stock into the company. And then we'll have the retained earnings, which will be the accumulation of revenue net income over the life of the business, less distributions in the form of dividends. So the dividends are going to come out of retained earnings.