What Are the Two Broad Categories of Stockholders' Equity?
Original post by Cam Merritt of Demand Media
A company's stockholders are literally the owners. And on the company's balance sheet, "stockholders' equity" lays out exactly what it is that they own -- the value of the company after subtracting all its debts and obligations. The bulk of stockholders' equity falls into two broad categories: paid-in capital and retained earnings.
Paid-in capital, also called contributed capital, is money that the company has received from selling shares of its stock. It's critical to understand that this category reflects only the price of those shares at the time the company sold them; changes in stock price have no effect on paid-in capital already on the balance sheet. So if a company sold 1 million shares at $10 apiece, its paid-in capital would rise by $10 million. If the value of each share jumped to $17, the paid-in capital would remain $10 million. The company doesn't get the extra $7 per share. Once it sells a share of stock, that share is "gone."
Elements of Paid-In Capital
A company's balance sheet will usually have several separate accounts that further break down where its paid-in capital came from. These include such things as sales of common stock and sales of preferred stock. If the company's shares have a "par value" -- essentially an archaic face value unrelated to the market price of the shares -- these accounts might include only the par value of the sales. Anything over par value would go into a separate account, something like "paid-in capital above par value." Another common category is "paid-in capital from treasury stock." Sometimes companies buy back their own shares and later resell them at a profit. That profit goes in this category.
When a company makes a profit, it can either distribute the profit directly to the shareholders as a dividend or hold onto it. The profit that the company keeps on its own books is its retained earnings, the second broad category of stockholders' equity. The longer a company has been around, and the more successful it is, the more likely that its retained earnings will exceed paid-in capital, often by a large amount. For instance, Apple Computer's June 2011 balance sheet showed about $12.7 billion in paid-in capital and $56.2 billion in retained earnings.
Role of Treasury Stock
As alluded to earlier, "treasury stock" refers to shares of stock that a company has bought back from its shareholders. The company in essence becomes a shareholder, although treasury shares carry no voting rights and earn no dividends. The cost of purchasing those shares is counted against stockholders' equity, though not under either the paid-in capital or retained earnings category. When and if the company resells them, any profit (or loss) gets recorded as paid-in capital.
- "Financial Accounting for MBAs," Fourth Edition; Peter Easton et al; 2010
- AccountingCoach; Balance Sheets - Stockholders' Equity; Harold Averkamp
- Yahoo Finance: Apple Balance Sheets
About the Author
Cam Merritt has been a professional writer and editor since 1992, specializing in articles about spectator sports, personal finance and law. He has produced content for "USA Today," "The Des Moines Register" and the "Better Homes and Gardens" family of magazines and websites. Merritt has a Bachelor of Arts in journalism from Drake University.