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.
Answer:
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
