You are part of a group of students analyzing the financial statements of a public company as part of a class project. At a team meeting, one of your group members makes the following statement: “Shareholders’ equity is really composed of two parts. The first part is the amounts contributed by shareholders, and the second is the company’s subsequent earnings. If a company reports a profit for the year, then shareholders’ equity increases by the same amount. On the other hand, shareholders’ equity is reduced by the amount of any dividends paid during the year.”

Required
Evaluate your friend’s response. Identify the elements that are correct and incorrect. For any elements that are incorrect, explain why.