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 The residual equity theory claims that equity holders' rights are superseded by all other stakeholders of the company.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,