Q:
Which of the following steps is inaccurate with respect to calculating a figure for shareholder's equity?
(a) Total liabilities must be subtracted from total assets.
(b) All dividends, be it for preferred or common shares, must be deducted from net income before it is added to the retained earnings component of shareholder's equity.
(c) Depreciation must be added back to net income before it is added on the retained earnings portion of shareholder's equity.
(d) All the capital that equity holders have invested into the firm must be added to the earnings that have been retained by the company over time.
A:

The correct answer is c.
Depreciation is added back to net income only when calculating for cash flow. In the case of shareholder's equity, all figures are derived using accrual methods. Therefore, even though net income is at best only an estimate of the true economic profit of the firm, only dividends are deducted from it before it is added to retained earnings.
CFA Level 1 LOS: 7.1.A.j

RELATED FAQS

  1. What is the difference between a company's equity and its shareholders' equity?

    Understand the difference and the interrelationship between shareholders' equity in a company and the company's actual total ...
  2. Which transactions affect the retained earnings statement?

    Retained earnings are the portion of a company's income that management retains for internal operations instead of paying ...
  3. How do you calculate retained earnings per share?

    Research the amount of retained earnings per share compared over time to understand whether or not a company uses its profits ...
  4. What is the difference between shareholder equity and net tangible assets?

    Find out more about shareholders' equity, net tangible assets, how to calculate these balance sheet items and the difference ...
  5. What does it signify about the state of a company if it has unusually high shareholders' ...

    Understand the meaning and calculation of shareholder equity and what a high level of shareholder equity signifies about ...
  6. What's the difference between retained earnings and revenue?

    See why retained earnings and revenue are both considered important measurements of a company's financial performance, and ...
RELATED TERMS
  1. Shareholder Equity Ratio

    A ratio used to help determine how much shareholders would receive ...
  2. Retained Earnings

    Retained earnings is the percentage of net earnings not paid ...
  3. Shareholders' Equity

    A firm's total assets minus its total liabilities. Equivalently, ...
  4. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  5. Net Income - NI

    1. A company's total earnings (or profit). Net income is calculated ...
  6. Statement Of Retained Earnings

    A financial statement outlining the changes in retained earnings ...
Trading Center