components of stockholders’ equity - class.aiu of stockholders’ equity 1 shareholders'...

Download Components of Stockholders’ Equity - class.aiu   of Stockholders’ Equity 1 Shareholders' equity—also known as stockholders' equity—is one of the two sources of capital on a firm's balance

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  • Components of Stockholders Equity


    Shareholders' equityalso known as stockholders' equityis one of the two sources of capital on a firm's balance sheet. The other section of the balance sheet includes assets and any liabilities to which the firm may become obligated. If a firm's assets total $1 million, and these assets have been financed with $300,000 of debt, the implication is that the owners of the firm (the shareholders or stockholders) must have the balance of the ownership, or 70%.

    The shareholders' equity section of a balance sheet typically looks like the following:

    Stockholders' Equity All amounts shown are in U.S. dollars.

    Common stock at par

    11,000 Preferred stock at par


    Paid-in capital in excess of par

    5,000 Retained earnings


    Accumulated other comprehensive income

    Net unrealized losses/gains on investments -1,000

    Net losses/gains on pensions 3,000

    Deferred losses on derivatives -1,000

    Total accumulated other comprehensive income


    Treasury stock

    -2,000 Total equity


    Total liabilities & Stockholders' equity


    The shareholders' equity section of a balance sheet typically includes the following sections:

    At a minimum, there must be common stock, which represents the owners of the company.

    The company may choose to issue preferred stock as a way to raise additional funds. The preferred stock gives preferred shareholders preference on receiving any dividends declared,

  • Components of Stockholders Equity


    but it does not give them a share of the company's ownership.

    Both common and preferred shares are recorded to reflect the share's par value, separate from any proceeds received from the sale of the stock in excess of this value. The excess is referred to as paid-in capital in excess of par.

    o When issuing stock, the concept of par value is to prevent distributions, or dividends, out of stockholders' equity from exceeding the minimum figure chosen by the company. This was originally meant to protect creditors from having excessive distributions to stockholders, thus lowering net asset-values below the value needed to cover creditor debt obligations; however, because most stocks are issued with a nominal par value ($1.00 or less), the point has become moot.

    Retained earnings represent the cumulative earnings of the company minus the cumulative dividends paid since the company began. This figure represents added value or wealth to the shareholders; that is, value accrued from the earning power of the business minus the portion of these earnings already paid out to shareholders (dividends), not from any further contributions of capital by them.

    o It should be further noted that the retained earnings figure is meant to reflect the earning power of the normal operations of the business and not some unusual situation. For this very reason, special gains and losses are reported separately on the balance sheet as accumulated other comprehensive income instead of appearing on the income statement as part of the retained earnings figure.

    Accumulated other comprehensive income does not show up on the income statement; it represents increases and decreases in shareholder value not attributed to changes to owners' stock holdings that would not show up in a routine income statement. These special categories of income include the following four major groups of activities:

    o Unrealized net-holding gains and losses on investments

    o Gains and losses from any amendments to postretirement benefit plans

  • Components of Stockholders Equity


    o Deferred gains and losses on derivative financial investments, such as hedges or options

    o Foreign currency translation gains and losses Treasury stock represents the value of stock repurchased by

    the company from stockholdersthat is, the cost to reacquire it. Companies typically do this when they feel their stock is undervalued in the marketplace. If they have or can raise sufficient cash, they will buy back shares at what they perceive to be a bargain price. Just like any other investment, if they can buy it back at a lower price and resell it later when stock values rise to what the firm believes they are worth, the existing stockholders will benefit.


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