Businesses report financial information through various vehicles. One such vehicle is the balance sheet, which contains a snapshot as of a given date of what a company owns (its assets), what it owes (its liabilities) and its net worth (stockholders' equity).
Read More: What Is Included on a Balance Sheet?
The difference between assets and liabilities equals stockholders' equity, a measure of the corporation's value to shareholders. The balance sheet specifies several components of equity, but the major two parts of stockholders’ equity are the capital accounts and retained earnings.
Capital Accounts: Stock
The stock capital account component of stockholders' equity is where a corporation tracks how much money it has raised by issuing shares of common stock and preferred stock. Common stock represents the ownership interest of investors in the corporation. Holders of common stock share in the growth of the company through higher dividends, stock buybacks, and capital appreciation (i.e., higher stock prices). These stockholders vote on important corporate matters, such as the composition of the company’s board of directors.
Preferred stock is a bond-like equity that pays dividends, and those dividends must be paid out before owners of common stock receive theirs. Owners of preferred stock receive a high, fixed dividend rate, but they lack voting rights. If a corporation is liquidated, the proceeds flow to owners of preferred shares ahead of those owning common shares, but behind the IRS and bondholders.
Additional Paid-In Capital
The stock accounts divide the proceeds raised from a corporation’s sale of shares into par value and additional paid-in capital. Par is a nominal share value that many states require. Additional paid-in capital is contributed capital in excess of par.
For example, suppose a company raises $20 million through the issue of one million common shares at $20 a share, each with a par value of $0.01. The paid-in elements of equity would assign $10,000 to common stock (1 million x $0.01 par) and the remainder, $19,990,000, to the additional paid-in capital account.
Capital Accounts: Equity Derivatives
The capital accounts also list certain equity derivatives, which are securities that can convert into stock, such as convertible preferred shares and stock warrants.
For example, stock warrants are long-term options on common or preferred stock. A warrant gives its owner the right, but not the obligation, to buy a set number of shares on or before an expiration date at a fixed price, called the exercise price. The value of the capital account for warrants is equal to the exercise prices times the shares per warrant.
Capital Accounts: Treasury Stock
Companies can buy back stock in the open market. These reacquired shares are classified as treasury stock because they are assigned to the corporate treasury rather than the open market. The corporation reports treasury stock at its cost (i.e. how much the company spent in the open market to reacquire the shares) and subtracts it from the other components of stockholders' equity. Treasury shares do not receive dividends and are excluded from the calculation of earnings per share.
Company Retained Earnings
The retained earnings account of stockholders' equity reports the amount of profit accumulated within the company since its inception, minus the cumulative dividends paid. At the end of each year, a company adds its net income to (or subtracts its net loss from) the retained earnings account. Dividends are paid from retained earnings.
Read More: The Difference Between Retained Earnings and Revenue
Accumulated Other Comprehensive Income
The accumulated other comprehensive income, or AOCI, account within the stockholders’ equity section of the balance sheet reports a special class of income that isn't included in net income. The types of income included in AOCI reflect transactions that have yet to conclude. Examples are the unrealized translation profit from foreign currency transactions and the current value of security investments in other companies. When an AOCI transaction closes, the company transfers the value from the stockholders' equity section of the balance sheet to the income statement.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.