Stockholders' Equity (Word Scrambles with Coaching)

The proceeds from issuing common or preferred stock are reported as paid-in capital or contributed capital. This represents the amount received by the corporation when the shares of stock were first issued by the corporation.

Example: If a corporation issues 1,000 new shares of common stock for $10 per share, the $10,000 is recorded as paid-in capital in the stockholders equity section of the balance sheet.

Retained earnings refer to the cumulative amount of net income of a corporation that has not been distributed to shareholders as dividends. It is a significant part of stockholders’ equity and indicates the amount of profit that has been reinvested in the corporation. (It is not sitting in the corporation’s cash accoumt.)

Example: If a corporation has made a profit of $50,000 and pays out $10,000 in dividends, the undistributed $40,000 will increase the corporation’s retained earnings.

Common stock is evidence of ownership in a corporation and gives shareholders voting rights. It is usually the primary (and often the only) type of capital stock issued by a corporation.

Example: If a company issues 5,000 shares of common stock with a par value of $1 each, the $5,000 will be reported in the paid-in capital section of stockholders’ equity on the corporation’s balance sheet.

Transactions involving a corporation’s own stock do not appear on the income statement as gains or losses. However, these transactions do affect the stockholders’ equity section of the balance sheet.

Example: When a corporation repurchases its own shares for $20,000 and later sells them for $30,000, the income statement is not affected. However, the amount of stockholders’ equity will have increased by $10,000.

Comprehensive income includes all changes in equity during a period except dividends and the purchase and issuance of the corporations’ own stock. Accumulated other comprehensive income is a stockholders’ equity line item/account which cumulates the total amount of comprehensive income.

Example: If a company has an unrealized gain on foreign currency transactions of $5,000 during the accounting period, the amount is added to the accumulated other comprehensive income section of stockholders’ equity. It is not added to retained earnings.

Treasury stock refers to a corporation’s own shares that have been repurchased but not retired. These shares reduce the total amount of stockholders’ equity on the balance sheet.

Example: If a company buys back 1,000 shares at $15 each, it records $15,000 as treasury stock, which is reported as a deduction from total stockholders’ equity.

When a cash dividend is declared, it creates a current liability until the dividend is paid. This reflects the corporation’s obligation to distribute funds to shareholders.

Example: Upon declaring a dividend of $1 per share on 1,000 shares, the corporation reduces Retained Earnings and increases the liability Dividends Payable by $1,000.

When a small stock dividend is declared, the market value of the new shares is transferred from retained earnings to paid-in capital, reflecting the increase in the number of shares issued.

Example: If a corporation has 10,000 shares outstanding and it declares a 5% stock dividend with a market price of $10 per share, $5,000 (5% x 10,000 = 500 shares x $10) is transferred from Retained Earnings to a paid-in capital account.

A stock split increases the number of shares outstanding and should decrease the market value per share without changing the total amount of stockholders’ equity.

Example: Assume a corporation has 1,000 shares outstanding. A 100% stock dividend will result in an additional 1,000 shares being issued. A 2-for-1 stock split will also result in a total of 2,000 shares.

A cash dividend is based on the number of outstanding shares of stock, which are the shares currently held by shareholders. The outstanding shares is also the number of shares issued minus the number of treasury stock shares.

Example: If a company declares a $0.50 dividend per share and has 10,000 outstanding shares, it will be paying $5,000 in dividends.

Stockholders’ equity is often referred to as the book value of a corporation, which is the reported carrying value of assets minus the reported amount of the liabilities.

Example: If a corporation’s balance sheet reports total assets of $1,000,000 and liabilities of $600,000, the stockholders’ equity, or the book value of the corporation, is $400,000.

Stockholders’ equity reflects the owners’ residual interest in the corporation’s assets. It is also referred to as the corporation’s net assets.

Example: If a corporation has assets of $500,000 and liabilities of $200,000, the stockholders’ residual interest is $300,000.

One major advantage of a corporation is the limited liability of its shareholders. This means a stockholder could lose the amount they invested in the corporation but not their personal assets.

Example: If a corporation goes bankrupt with $1,000,000 in debt, a shareholder who invested $10,000 might lose their $10,000 investment, but will not be liable for the corporation’s remaining debt (unless the stockholder personally guaranteed the corporation’s debts).

Retained earnings are the cumulative amount of a corporation’s earnings that have not been distributed to shareholders as dividends. Typically, the amount of retained earnings is reinvested in the business assets or used to pay down debt.

Example: A corporation with $150,000 in cumulative net income and $50,000 in dividends has retained earnings of $100,000. However, the $100,000 is probably not sitting in a bank account.

A dividend is a distribution of a portion of a corporation’s earnings to its shareholders, usually in the form of cash. Dividends are not reported as an expense on the corporation’s income statement.

Example: If a company declares a $0.50 dividend per share and a shareholder owns 200 shares, the shareholder will receive a dividend of $100.

A corporation might restrict its retained earnings for a specific purpose, such as future expansion or to meet certain debt covenants. This restriction places a limit on the amount of retained earnings available for declaring dividends.

Example: If a corporation restricts $20,000 of retained earnings for future building expansion, this amount is disclosed and reduces the amount that can be declared for dividends.

A stock split increases the number of shares outstanding and decreases the par or stated value of each share proportionally. A stock split does not change the total stockholders’ equity of the corporation. A stock split is often used to reduce the market price of each share.

Example: If a company with 100 shares with a market value of $80 each undergoes a 2-for1 stock split, shareholders will receive 200 shares that will likely have a market value of $40 each.

Dividends in arrears are the unpaid dividends on cumulative preferred stock. The dividends in arrears must be paid before declaring any other dividends on common stock.

Example: If a corporation has not paid dividends on its cumulative preferred stock for two years, these unpaid amounts are considered dividends in arrears and must be disclosed in the corporation’s financial statements.

Treasury stock represents a corporation’s own stock that has been repurchased and is held by the corporation (but not retired). The amount of treasury stock is shown as a subtraction in the stockholders’ equity section of the balance sheet.

Example: If a company buys back 100 of it shares at $30 each, the cost of $3,000 is recorded in the account Treasury Stock. The debit balance in Treasury Stock will reduce the total amount of stockholders’ equity

Preferred stockholders have preferential treatment over common stockholders regarding dividends and liquidation proceeds. The preferred stockholders must receive their dividends before any dividends are distributed to common stockholders.

Example: If a corporation declares dividends, preferred stockholders (if any) must be paid their dividend before the common stockholders receive dividends.