Businesses obtain the economic resources used in their operations either through incurring debts and other such obligations to other economic entities or through receiving them as investment. Investment put into the business is called "equity." Corporations are independent legal entities that often raise much of their startup capital through selling stock shares that offer rights and benefits similar to those of ownership. As such, these stockholders can be considered the owners of corporations, explaining why corporate equity is called "stockholders’ equity."
It is true in all cases that a business’s assets equal its liabilities and its equity, representing that a business acquires its resources either through incurring debts or through receiving investment. Equity is the portion of the business’s assets that it obtained using its own resources as represented by the investment placed in it by its owners and the earnings that the business itself places in its operations.
Paid-in capital represents the sums that the corporation’s stockholders have paid to it in exchange for the stock shares. For example, if a corporation issued 20,000 shares in exchange for $3 per share, that corporation has raised $60,000 in paid-in capital. Some corporations issue different classes of shares and choose to use different paid-in capital accounts to keep track of the capital raised through issuing these different classes of shares.
Retained earnings represent the earnings that the corporation chooses to reinvest in its operations rather than distribute to its owners as dividends. In each time period, a corporation chooses to distribute some of its earnings as dividends and then adds the reminder to its retained earnings. It is possible for a corporation to declare more in dividends than what it has earned for the period -- and if this continues long enough, it is possible for a corporation to possess negative retained earnings.
Other Equity Accounts
Although paid-in capital and retained earnings are likely to be the most prominent accounts listed under stockholders’ equity, they are not the only possible accounts. What accounts appear under stockholders’ equity depend on the specific corporation’s past and present activities. Examples can include contributed capital donated to the corporation and unrealized gains and losses on financial instruments held by the corporation.