What is Stockholder Equity?

The stockholders’ equity (often referred to as the book value of the company) is the number of assets available to the stockholder after its entire liabilities is paid off. The stockholders’ equity is also sometimes referred to as owner's equity. The stockholders’ equity or book value generally includes common stock, treasury stock retained earnings. It is an indicator of a company's financial strength and is an important item on the company's balance sheet.

Is Stockholder or Shareholder the Same?

The term "stockholder and shareholder" both refer to the owners of the company. A stockholder or shareholder can either be an individual or any business entity. The term "stockholder" usually denotes the holder of stock or an inventory, on the other hand, "shareholder" denotes holder of a share. The stockholder and shareholder, both are issued dividends.

They both carry the same rights concerning voting. The use of the term "shareholder" is however more technically correct as far as the company ownership is concerned.

What is Paid-in Capital?

The paid-in capital in book value of the company is referred to as the amount of cash or any other assets that a shareholder gives the company in exchange for its stocks par value plus any amount that is paid in excess to it. It is generally described as the capital contributed by the stockholders of the company.

For example, A Company Tata Motors Ltd. issues 3000 shares which have a par value of $3 per share. The market price of the share $20/share. So, here the paid-up capital will be the total amount which the investor pays to buy the shares. Since $3 is the par value and the market price is $20, so the excess amount per share paid by the investor is $17 $(\$20-\$3$).

Therefore, the total paid-up capital which the investor pays will be the total par value of the share and the value over par,

i.e.($3000\times \$3+3000\times \$17=\$60,000$ $3000\times \$3+3000\times \$17=\$60,000$)

What is Preferred, Stock?

Preferred stocks are those wherein the stockholders claim priority over dividend distributions as compared to common stockholders. The preferred stocks also do not carry any voting rights. In a case where a company is going to be liquidated, the preferred stockholders have a priority claim on the value of assets of the company as quoted in the balance sheet, as compared to the common stockholders. There are also certain preferred stocks which are convertible which means that it can be exchanged for a given number of common stocks but under special circumstances.

What are Retained Earnings?

Retained earnings are the net income of the company which is left after the required dividends are paid to the shareholders. The surplus money is usually invested back into the business to expand its business operations or launch a new product which in turn may help the management to target more sales.

The retained earnings or the net income so earned is also utilized by the shareholders to buy back shares of the company or to repay the debts of the company. The retained earnings generally grow and get accumulated over time.

What is the Effect of Retained Earnings on Stockholders' Equity?

The retained earnings form a very important part of the stockholders’ equity in the balance sheet of the company. The increase in retained earnings increases the stockholder's equity balance. The companies which usually pay dividends need to strike a balance between the retained earnings and dividends that are being paid to the shareholders. The earnings are usually retained by the companies to improve their financial position.

What is Treasury Stock?

It is a kind of stock that is repurchased from the stockholders by the company that once issued it. The result is that the repurchase of the stock reduces the stockholder's equity balance on the balance sheet. The treasury stocks are an important constituent of stockholder's equity but do not carry any voting rights.

What are the Methods of Calculating Treasury Stock?

There are commonly two types of accounting for such stocks.

A. The Cost method: This method ignores the par value of the stock and takes into account the value which the company pays during the repurchase of the shares. Under this method, the amount for the treasury stock is usually included in the stockholders’ equity portion of the balance sheet. 

Under this method when the shares are repurchased the treasury account is debited to decrease the stockholders’ equity balance on the balance sheet and the cash account is credited to record the expenditure incurred in repurchasing the shares. In the case where the treasury stocks are later resold, there is an increase in the cash account which is debited, and this stock account is decreased thereby increasing the stockholders’ equity balance on the balance sheet.

B. The Par-value method: Under this method when the shares are repurchased the treasury stock is debited to the par value of the shares that are being repurchased, and subsequently there is also a decrease in the stockholders’ equity balance in the balance sheet. The additional paid-in capital account is also debited to record the amount which was originally paid by the stockholders more than the par value. The cash account is credited with the total amount paid in for the repurchase of the shares.

Example of Treasury Stock: 

XYZ Company originally had sold 5,000 shares of common stock, with a $1 par value of $45 per share. Therefore, it had $5,000 common stock ($5,000shares*\$1parvalue$) and $220,000 additional paid-in capital [$5,000shares*(\$45-\$1paidinexcessofparvalue$)] on its balance sheet. XYZ Company had excess cash and believed that its stock is trading in the market below its intrinsic value. As a result, it decided to repurchase 1,000 shares of its stock at $60 for a total value of $60,000.

So, under the cash method, the treasury account would be debited for $60,000 and cash credited for $60,000, thereby decreasing the stockholders’ equity balance in the balance sheet. Under the par value method treasury stock would be debited for $1,000 (1,000 shares x $1 par value) and the additional paid-in capital would be debited for $59,000 [$1,000sharesx(\$60repurchaseprice-\$1parvalue$)], and cash would be credited for $60,000.

Formulas

Here,

C= Cash Dividends.

S = Stock Dividends.

Common Mistakes and Pitfalls

It must be taken care of while computing stockholders’ equity that the cash flows are properly calculated with proper forecasting. The discount rate calculation and the riskiness involved for the company should also be taken into consideration. The inconsistencies and errors should be removed, to avoid further difficulty in computing stockholders’ equity.

Related Concept:

• Equity
• Capital.
• Dividends.
• Liabilities.
• Net worth.
• Credit.

Context and Application

This topic is significant in professional courses, especially for

• B.com (Honors) (Bachelor of Commerce)
• M.com (Master of Commerce)
• Chartered Accountants (CA)
• Company Secretary (CS)
• MBA (Master in Business Administration) (Finance)