What Is Stockholders' Equity in Accounting?
Most businesses start up and continue to run their operations using a combination of debt and their own resources. Debt and other such obligations that businesses owe to others are recorded as liabilities on their balance sheets. In contrast, resources invested into the businesses are called equity. For corporations, equity is called stockholders’ equity, since stockholders are considered the owners. Equity is always equal to assets minus liabilities.
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Stockholders’ Equity
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Corporations, partnerships, and sole proprietorships are the most prominent classes of businesses. Corporations are unusual compared to the others in that they are considered independent legal entities, rather than extensions of their owners. As such, corporations raise much of their start-up capital through selling shares of capital stock to investors, including stockholders.
Paid-in Capital
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Paid-in capital is one of the most prominent accounts listed under stockholders’ equity. It is the sum of capital that the corporation has raised through selling its shares to investors. Since corporations can issue multiple classes of shares possessing different benefits and responsibilities, paid-in capital is sometimes divided into multiple accounts for better clarification of the composition of the capital paid to the corporation. For example, if a corporation issued both common and preferred shares, it might choose to record paid-in capital raised through selling both in one combined account or record them separately as common paid-in capital and preferred paid-in capital.
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Retained Earnings
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Retained earnings is another prominent account listed under stockholders’ equity and represents the accumulated earnings that the corporation has reinvested in its operations. In each time period that passes, the corporation declares dividends to be paid to its stockholders out of its net income and then adds the remainder to its retained earnings. This is because the income that the corporation does not distribute as dividends is assumed to be used up in its operations in subsequent periods. It is possible for corporations to declare more dividends to be paid out than what it has earned for the period-ans even for the corporation’s retained earnings to be negative if this happens too often.
Other Accounts Listed Under Stockholders’ Equity
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Numerous other accounts can be listed under stockholders’ equity, although the most prominent are share capital and retained earnings. Such accounts all represent value that the corporation and its stockholders can be considered to own outright, rather as debts. Examples of such accounts can include donated capital and unrealized gains and losses on financial statements still held by the corporation.
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References
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