Owners' Equity
Essay by raven2216 • June 23, 2016 • Term Paper • 532 Words (3 Pages) • 925 Views
Owners’ equity, also known as stockholders equity, in a corporation is defined as stockholders’ equity, shareholders’ equity, or corporate capital. It is the owner’s investment or capital in the business. To operate a business you need a prime source of financing which comes from investors. When investors invest money in a company they become owners of the business by acquiring equity in it (Kieso, et al. 2013).
Equity is made up of different categories. First, there is paid-in capital. Paid-in capital includes capital stock and additional paid-in capital. It is the total amount paid in on capital stock. That is, the amount provided by stockholders to the corporation for use in the business. Contributed capital also includes items such as the par value of all outstanding stock and premiums less discounts on issuance. Then there is earned capital. Earned capital is a company’s profit generated from operations. It consists of all the company’s undistributed income (Kieso, et al. 2013).
Why is it important to keep paid-in capital separate from earned capital? Paid-in capital and earned capital are funds from different sources. Paid-in capital is money that the company has raised from equity and earned capital is money that a company has generated from operations. It is important to keep them separate so that investors can see that the company is able to meet obligations through operations alone. Combining the two would result in a misrepresentation of the earning potential of the corporation (Kieso, et al. 2013).
As an investor, is paid-in capital or earned capital more important? To an investor, paid-in capital and earned capital are equally important. Investors use both accounts to evaluate the strength and liquidity of the company. Investors also compare capital accounts from year to year to determine if the company is growing with enough reinvested funds to keep it operating. Earned capital is important to investors because it shows the potential of the corporation and the value of their investment.
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