Stockholders’ equity represents the net worth of the business after considering the financial resources invested through borrowing. The total stockholders’ equity section equals total assets minus total liabilities. Investors review the stockholders’ equity section of the balance sheet to determine how well the company manages stockholder investments and to evaluate the total worth of the company. Several different components contribute to stockholders’ equity.
Capital stock refers to the shares of the company sold to investors. Each share represents partial ownership and provides benefits to the shareholder. These include the right to receive dividends when the company pays them, the right to receive any remaining assets at liquidation and voting rights. Each share of capital stock includes a par value, or a dollar amount assigned to each share. This value allows the company to record the issuance of capital stock in the financial records. The company reports capital stock at its par value. The company includes a note in the financial statements, which communicates the number of shares outstanding and the par value of each share.
Paid In Capital
Paid in capital refers to money the company received when it issued the stock. The company sells the stock for a price agreed upon between the investor and the company. This amount differs from the par value. The company records a change in both capital stock and paid in capital when it sells the stock. Paid in capital represents the difference of the money received between the par value and the selling price of the stock.
Treasury stock represents shares of stock the company purchased of itself. Companies purchase its own stock through the stock exchange in order to reduce the number of outstanding shares, to manipulate the stock price or to award shares to employees. The company reports treasury stock as a deduction from stockholders’ equity for the total amount it pays.
Retained earnings form the component of stockholders’ equity not invested by stockholders. The company generates retained earnings through its income production. Net income increases the retained earnings and a net loss decreases retained earnings. When the company pays dividends to the stockholders, retained earnings decrease by the dividends paid.