Components of Stockholders’ Equity

Shareholders' equity—also known as stockholders' equity—is 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 this:

Stockholders' Equity

All amounts shown are in U.S. dollars.

Common stock at par

11,000

Preferred stock at par

2,000

Paid-in capital in excess of par

5,000

Retained earnings

2,000

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

1,000

Treasury stock

-2,000

Total equity

19,000

Total liabilities & Stockholders' equity

36,000

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, 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 noted further 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 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

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

stockholders—that 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.