15-8 Stockholders’ Equity
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Case 15-8 Classification of Stockholders’ Equity
The Major Subdivisions of The Stockholders’ Equity Section
There are five major subsections of the stockholders’ equity section, they are paid-in
capital, earned capital (retained earnings), other comprehensive income, treasury stock, and
noncontrolling interest. Each has a separate but vital role in classifying each section on the
company’s balance sheet for investors and creditors.
Paid-in capital has legal capital and additional paid-in capital, legal capital is the par,
stated value, or the entire proceeds if no par or stated value is in the stock issue. Additional paid-
in capital is the amount received more than the par or stated value. Earned capital, often referred
to as retained earnings, is the accumulated net profits of a corporation. These net profits have not
been distributed as dividends. Retained earnings can be further divided into appropriated and
unappropriated sections in the shareholders’ equity section of the balance sheet. Appropriated
funds are already spoken for and cannot be disbursed as dividends, and unappropriated funds are
not tied to any predetermined object. According to Schroeder et al. (2019), “Generally accepted
accounting principles prohibit firms from including certain increases or decreases in assets or
liabilities in earnings. Instead, they are reported in stockholders’ equity as other comprehensive
income.” Treasury stock is the reacquisition of the company’s own stock, the reacquisition
lowers both the assets and the stockholders’ equity. Lastly, according to FASB (2001) ASC 810, a
noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable,
directly or indirectly, to a parent. A noncontrollable interest is sometimes called a minority
interest.”
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Subdividing the amount of stockholders’ equity, including legal, accounting, and other
considerations.
There are many reasons to subdivide the stockholders’ equity section of the balance sheet,
companies must ensure that appropriated funds are set aside and not used accidentally. There are
legal, accounting, and other considerations to account for as well. The legal capital is usually the
value of the outstanding share and is set up to protect creditors. For the accounting aspect of the
stockholders’ equity, assets must equal liabilities plus stockholders’ equity. The difference
between the assets and the liabilities results in the balance of stockholders’ equity, it is then
separated out even further to contributed capital, retained earnings, other comprehensive income,
treasury stock, and noncontrolling interest. Separating these out ensure that the resources are not
spent elsewhere or incorrectly.
Kinds of transactions that will result in paid-in or permanent capital in excess of legal or
stated capital.
The three types of transactions that result in paid-in or permanent capital, in excess of
legal or stated capital, they are selling the stock at above the par value, quasi-reorganization, and
conversion. Selling stock at above the par value is also referred to as additional paid-in capital.
Quasi-reorganization can give the organization a fresh start, by doing a quasi-reorganization the
company can write off any overvalued assets and eliminate any deficit balances. According to
Bunyaminu et al. (2019), “It is worth mentioning that the retained earnings account is subject to
"manipulation" via corporate quasi-reorganizations and stock dividend declarations.”
Conversion is a feature that makes it more attractive for potential investors to invest in a
company, the exchange ratio is tied to the market price of preferred stock to the price of common
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stock. According to Schroeder et al. (2019), “the proper accounting treatment is to transfer the
par value of the preferred, plus a proportionate share of any additional paid-in capital on the
preferred stock, to common stock.”
Paid-in Surplus and Earned Surplus Substitute Terms.
Paid-in surplus and earned surplus makes it seem like the company has an excess liquid
surplus that the company can use at its disposal, it does not. To make it more obvious that this is
not liquid it should be called additional paid-in capital.
Christian Worldview
As noted above, quasi-reorganization can manipulate the retained earnings account, making it
hard for potential investors to make an honest determination about investing in the company.
Investors need to remember the words of Matthew 7:15 “Beware of false prophets, who come to
you in sheep's clothing but inwardly are ravenous wolves.” And not make a bad investment in a
manipulative company.
15-8 Stockholders’ Equity
References
Bunyaminu, A., Mohammed, I., & Issah, M. (2019). Business failure prediction: A tri-
dimensional approach. The Journal of Applied Business and Economics, 21(2), 80-
100. https://doi.org/10.33423/jabe.v21i1.1456
ESV. (2016). Matthew 7:15, (ESV). Bible Gateway. Retrieved December 3, 2022, from
https://www.biblegateway.com/
FASB. (2001, August). FASB Accounting Standards Codification 810-10.
https://asc.fasb.org/1943274/2147481381
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and
Analysis: Text and Cases (13th ed.). Retrieved December 2, 2022, from Wiley Global
Education US. https://mbsdirect.vitalsource.com/books/9781119577713
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