Paid-in Capital and Retained Earnings, Research Paper Example

When a company raises funds through an equity issue, the total receipts consist of the stock’s par value as well as the additional capital which is also called paid-in-capital. In other words, a stock sold at a rate of $13 per share to the public with a par value of 1 cent bought in $12.99 as paid-in-capital for each share. Retained earnings represent that portion of net income that has not been distributed to the shareholders as dividends. In a balance sheet, retained earnings represent all of the net income that the company retained over the years since its incorporation (AccountingCoach, LLC).

Paid-in-capital could also be thought of as contribution by the company’s owners including both common and preferred stockholders. The amount of paid-in-capital is positively related to the demand of the company’s equity issue. The higher the demand, the greater the paid-in-capital is which explains why Facebook’s shares started trading at $38 (Guglielmo, 2012)

Similarly, retained earnings could be thought of as company’s income which is owned by the shareholders but the management used its authority to retain it for asset replacement or reinvestment purposes instead of distributing it to the shareholders. The company’s leadership sometimes also decides to retain a portion of or all of the net income because they believe they can invest the earnings more profitably than what the investors may earn by investing on their own. Retained earnings can also be used to pay off company’s debts (Howell) which help reduce leverage and improve profitability and liquidity by lowering annual interest payments.

The longer a successful company has been in operations, the higher is the probability of its retained earnings exceeding its paid-in-capital Apple’s paid-in-capital and retained earnings were $12.7 billion and $56.2 billion as of June 2011 (Merritt).

References

AccountingCoach, LLC. (n.d.). Paid-in Capital or Contributed Capital. Retrieved September 10, 2012, from http://www.accountingcoach.com/online-accounting-course/17Xpg03.html#paid-in-capital

Guglielmo, C. (2012, September 10). LinkedIn’s Hoffman Says Facebook Shares Will Be A ‘Good Buy,’ IPO Debacle May Have Been ‘Inevitable’. Retrieved September 10, 2012, from http://www.forbes.com/sites/connieguglielmo/2012/09/10/linkedins-hoffman-says-facebook-shares-will-be-a-good-buy-ipo-debacle-may-have-been-inevitable/

Howell, R. (n.d.). Advantages & Disadvantages of Retained Earnings. Retrieved September 10, 2012, from http://smallbusiness.chron.com/advantages-disadvantages-retained-earnings-20688.html

Merritt, C. (n.d.). What Are the Two Broad Categories of Stockholders’ Equity? Retrieved September 10, 2012, from http://wiki.fool.com/What_Are_the_Two_Broad_Categories_of_Stockholders%27_Equity%3F#Paid-In_Capital