Eaquity Theories of Accounting
Following is an income statement calculated based on the different equity theories of accounting.
Entity Theory Proprietary Theory Orthodox Unorthodox Residual Equity Theory
Revenues $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000
Less:
Operating Expenses
Cost of goods sold $400,000 $400,000 $400,000 $400,000
Depreciation $100,000 $100,000 $100,000 $100,000
Salaries and Wages $200,000 $200,000 $200,000 $200,000 Operating Income $ 30,000 $300,000 $300,000 $300,000
Less
Bond Interest $80,000 $80,000 $80,000
Dividend on Preferred Stock $30,000 $30,000
Dividend on Common Stock $100,000 Net Income $220,000 $300,000 $90,000 $190,000
The proprietary theory assumes that owners and the firm are virtually identical. The entity theory states that the firm and the owners are separate entities. The residual equity theory claims that equity holders ' rights are superseded by all other stakeholders of the company.
If the preferred stock were convertible at a ratio of two preferred shares for one shares of common stock, at the time of the conversion, there would be no preferred stock dividend to report. Therefore, under the residual method, net income would increase by the amount of dividend granted to the common stock. The unorthodox method would be affected in that it would shift the dividend on preferred stock to the dividend on common stock.
References
Evans, T. G. (2003). Accounting Theory: Contemporary Accounting Issues. Ohio: Thomson South-Western.
Schroeder, R. G., Clark, M. W., and Cathey, J. M. (2005). Financial Accounting Theory and Analysis, Text Reading and Cases: Eight Edition. New York: John Wiley & Sons,
Entity Theory Proprietary Theory Orthodox Unorthodox Residual Equity Theory
Revenues $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000
Less:
Operating Expenses
Cost of goods sold $400,000 $400,000 $400,000 $400,000
Depreciation $100,000 $100,000 $100,000 $100,000
Salaries and Wages $200,000 $200,000 $200,000 $200,000 Operating Income $ 30,000 $300,000 $300,000 $300,000
Less
Bond Interest $80,000 $80,000 $80,000
Dividend on Preferred Stock $30,000 $30,000
Dividend on Common Stock $100,000 Net Income $220,000 $300,000 $90,000 $190,000
The proprietary theory assumes that owners and the firm are virtually identical. The entity theory states that the firm and the owners are separate entities. The residual equity theory claims that equity holders ' rights are superseded by all other stakeholders of the company.
If the preferred stock were convertible at a ratio of two preferred shares for one shares of common stock, at the time of the conversion, there would be no preferred stock dividend to report. Therefore, under the residual method, net income would increase by the amount of dividend granted to the common stock. The unorthodox method would be affected in that it would shift the dividend on preferred stock to the dividend on common stock.
References
Evans, T. G. (2003). Accounting Theory: Contemporary Accounting Issues. Ohio: Thomson South-Western.
Schroeder, R. G., Clark, M. W., and Cathey, J. M. (2005). Financial Accounting Theory and Analysis, Text Reading and Cases: Eight Edition. New York: John Wiley & Sons,
References: Evans, T. G. (2003). Accounting Theory: Contemporary Accounting Issues. Ohio: Thomson South-Western. Schroeder, R. G., Clark, M. W., and Cathey, J. M. (2005). Financial Accounting Theory and Analysis, Text Reading and Cases: Eight Edition. New York: John Wiley & Sons, Inc.