Balance Sheets: Equity vs. Retained Earnings net, question, balance, correct

bigredhockey55

I’m a little confused about how Equity and Retained Earnings work.  I just answered a QBank question that asked me to calculate ROE based on the balance sheet and income statement, where net income was 4127, common stock was 4000 and retained earnings was 4354.  I would have thought that one just did (net income / common stock), but the correct calc is (net income / (stock + retained earnings)).  
Can somone clarify Equity to me.  I think what confuses me the most is why Equity is listed on a balance sheet in the first place.  Isn’t just a calc of Assets - Liabilities?  It doesn’t seem to exist concretely without these.  I seems circular and redundant to need to show it on a balance sheet.
The way I’ve explained equity to myself is to think of it like my house and my mortgage.  I have a $500K house, my mortgage is $400K, therefore I have $100K equity.  I get that.  But then how does the retained earning fit into that?  Does the analogy flow that if I had rented a room (say for $4K a year) and had made $20K from that and not spent it, that would be retained  earnings, so therefore the $100K of equity is $80K stock and $20K retained earnings shown on my balance sheet?   So to calculate my ROE, I would do $4K / ($100K).  
If the above is correct, what is the point of stripping out the retained earning from the stock on the balance sheet?  Is it to display how much $ have come from initial investments vs. how many $ have come from earnings?

sabre

Simplified Case
Ending value of Equity = Opening Equity + Net Income - Dividends
Retained Earnings = NI - Dividends
I think the point of testing in the question was to first find the ending value of equity and then calculate ROE based on that.

spartan1

Other equity considerations include things like distributions/dividends which have, for the most part, nothing to do with liabilities. To your point about Equity not really being needed, this is an example of something that isn’t the residual of an assets minus liability entry. It is strictly an assets (cash) and equity(shareholder dist/dividend) entry. And in this case it’s slightly unique because it’s a debit to equity when you might typically think as equity/equity accounts as being positive for the most part.

SFoyil

Return on Equity = Net Income / Shareholder Equity
Shareholder Equity = Common Stock + Retained Earnings
Quote:The way I’ve explained equity to myself is to think of it like my house and my mortgage. I have a $500K house, my mortgage is $400K, therefore I have $100K equity. I get that. But then how does the retained earning fit into that? Does the analogy flow that if I had rented a room (say for $4K a year) and had made $20K from that and not spent it, that would be retained earnings, so therefore the $100K of equity is $80K stock and $20K retained earnings shown on my balance sheet? So to calculate my ROE, I would do $4K / ($100K).

So your Equity equals $120K = $100K (house 500 - mortgage 400) + $20K (you’ve earned and not spent)
and your ROE is $4K / $120K.

brk1yn

Assert = Capital + Liabilities (break even point for any business)
Asserts Asserts  Capital + Liabilities (profitable situation)
A firm owns money not only to creditors but also to its owners, that is why we equation asserts = Capital + Liabilities. If asserts are to be liquidated, value asserts should always be able to pay back money it owns owners and creditors.
1. Look at this way.. Asserts are financed, by capital (Equity (owner’s/shareholders money) + Debt (long term loans))
2. Liabilities (money owned to creditors, suppliers etc) is what company owns to creditors, banks etc.
3. Net Income which is calculated using in Income Statement. Can be given to equity shareholder in form of dividends or it can be ‘retained’ in business in form of retain earnings. Retain earning can be used in variety of ways, for instance, financing R and D project etc.