Corporations are owned by their shareholders, and the "shareholders' equity" section of the company balance sheet tells how much that ownership is actually worth. In most cases, equity breaks down into two categories: "contributed capital," or "paid-in capital," which is the net proceeds from stock sales; and "earned capital," which is the profits retained by the company. Some companies have additional equity items that don't fit neatly in either category.
Companies sell shares of stock to the public to raise capital, and the money from those sales becomes the foundation of shareholders' equity. Depending on how the company has structured its stock, paid-in capital might be spread across several accounts within the equity section of the balance sheet. If the company has both common and preferred stock, for example, each class might be listed separately. Further, some companies' stock has a face value, called a "par value" -- usually a penny or a fraction of a cent. When such a company sells a share at market price, it might separate the sale into two equity accounts: the par value of the sale, and the amount in excess of par value.
Companies will occasionally buy shares of their own stock back from investors. They might do so to try to boost the stock price, improve the company's earnings-per-share ratio or even obtain shares to give to employees. Money spent to buy back stock goes under shareholders' equity as "treasury shares" or "treasury stock." Since this is money the company has spent on stock sales -- rather than received from them -- this is a "contra" account, meaning that it's always negative. For example, if a company has stock sales totaling $20 million and a treasury shares account of $2 million, then equity is $18 million.
A company doesn't get all its money from stock sales, of course. At some point, the company should start turning a profit from its operations. And since the shareholders are the owners, that profit belongs to them. The company can give them some of the profits directly as dividends. Any profit not distributed as a dividend goes into a shareholders' equity account called "retained earnings." Simply put, it's the accumulated total of all the profits the company has had since the day it incorporated. By the same token, any losses posted by the company come out of retained earnings.
Some things earn income -- or cause losses -- for a company, but for various legal and structural reasons they're not included on the company's income statement, and therefore not reflected in the profit that goes into retained earnings. This income still has to be accounted for in the shareholders' equity section, so it goes in an account called "accumulated other comprehensive income," or AOCI. Items in AOCI may include foreign currency transactions or changes in the value of the company's investments. Many companies have no AOCI at all.
- "Financial Accounting for MBAs," Fourth Edition; Peter D. Easton, et al; 2010
- AccountingCoach.com; Treasury Stock and Accumulated Other Comprehensive Income; Harold Averkamp
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