Q1: For a company, what are the two main components, or parts, of equity in its balance sheet? Describe each of these two main components of equity for a company.
For a company, the two main components of equity are Issued capital and Reserves.
Also, see Martin’s videos Issued Capital and Reserves
Issued capital is the amount of equity contributed by equity investors to a firm.
AASB 101 Presentation of Financial Statements para 54 (r) requires issued capital to be shown separately for companies:
“The statement of financial position shall include line items that present the following amounts:
(r) issued capital … attributable to owners of the parent.”
You will see in Ryman Healthcare’s 2017 Balance sheet (Ryman Healthcare 2017 Annual Report p. 22) that Issued capital as at 31 March 2017 is $33.3m; and this is the same amount as at 31 March 2016. Indeed, if we look at all the balance sheets of Ryman Healthcare since it floated on the New Zealand Stock Exchange in July 1999, we will see that its Issued capital has remained constant at $33.3m. This is the equity (that is, Issued capital) that it raised from investors when it floated. These investors included my three children (then aged 11, 10 and 5 years) and also my wife (age not disclosed). When it floated, Ryman Healthcare issued an additional 18.5 million shares at $1.35 each. This raised new capital of $25m and the company had a total of 100 million shares on issue.
The remainder of its Issued capital was from capital contributed by investors when the company was a private company, and included the initial founding investors and subsequent private equity investors. So since it floated in July 1999, Ryman Healthcare has raised exactly zero additional equity from investors. The startling, consistent and spectacular growth of Ryman Healthcare since it floated has all been funded ‘internally’ by Ryman Healthcare from ‘its own resources’ as well as by steadily increasing its borrowings from its bankers (debt investors). The story of how Ryman Healthcare has been able to achieve this growth and value creation is best left for another day, when we study ACCT13017 Financial Statement Analysis, the capstone unit at the end of our degree; watch this space in a few years, once you have built sufficient understanding and foundations in accounting in your degree for us to be able to explore this fascinating story in quite a deal of depth.
Also, see Martin’s videos Issued Capital
Nowhere in the accounting standards (nor in AASB CF Framework or in the Corporations Act) are reserves actually defined. There are examples of where reserves need to be established (such as when Property, plant & equipment is revalued upwards to fair value); but nowhere is the term ‘reserves’ actually defined. But one thing we can see from AASB 101 paragraph 54 (r) is that reserves are the items of equity other than those contributed by owners (Issued capital). Issued capital and reserves are the two parts or aspects of equity that need to be disclosed. The reserves we will look at in this section are part of the range of reserves that can be set up based on transfers directly to equity from Other comprehensive income (for example, when revaluing Property, plant & equipment upwards to fair value) or from transfers from Retained earnings. In the next section, we will look at the rather special type of reserves, Retained earnings, into which all the Net profits of a firm are transferred at the end of each year.
The definition of reserves that we will use in this chapter is:
“Reserves are those parts of equity not represented by issued capital. Reserves represent increases in the value of the net assets of a business over time that have not been distributed to equity investors but retained in a business to support its growth.”
Also, see Martins videos Reserves