Owners_Equity

Owner’s Equity Paper Arbra Jones Intermediate Financial Accounting ACC/423 Professor Scott Ronk October 29, 2012 Owners’ Equity Paper Owner’s Equity covers the interest of common shareholders and preferred shareholders have in a business. Individuals that have paid-in capital into a company to provide money which aides in the company day-to-day operations are considered stockholders. The following is a brief summary analysis of the importance of separating paid-in capital from earned capital, as well as an analysis determining if paid-in capital is more desirable than earned capital from an investor’s point of view, including if investors find basic earnings per share is more or less important than diluted earnings per share. Separation of Capital The main reason for the separation of paid-in capital from earned capital is because paid-in capital is the amount of capital that the shareholders have made into the business for business use; while earned capital is the amount of capital the shareholders have made a profit from the business. Earned capital is the result of net income. On the balance sheet earned capital is located under owner’s equity section and can also be found under retained earnings. Because earned capital is the amount of profit that an organization has made, this amount is invested back into the organization. Paid-in capital, the capital that an organization receives from its investors and shareholders, is also classified as contributed capital (Kieso & Weygandt, 2010). To be considered paid-in capital an investor would buy stock that has a selling price per share of $15 but is purchased by the by the investor for $20. The difference of $5 would be paid-in capital. This excess is the amount an organization will use for purposes of the business. Paid-in capital covers amounts of par value stock and any premiums minus discounts when issued. It is important to identify paid-in capital from earned capital to help investors determine the two amounts are clearly stated. If these two items were combined then it would be possible to overstate net income thereby invalidating an organizations financial statements. Paid-in or Earned Capital Investors are more interested in the money a company earns from its operations versus money earned from selling stock. Earned capital that is reported on the organization’s financial statements allows their investors the opportunity to see how well the organization is doing. Whereas companies that show a large amount of paid-in capital could be viewed as an underperformer making it a less than attractive to investors Basic versus Diluted Diluted earnings per share (diluted EPS) details all potential diluted common shares outstanding for a specified period, information investors find necessary when trying to decipher a company’s net income. The calculation used to determine diluted earnings per share involves dividing net income, or preferred dividends, by the weighted average of shares outstanding. To determine diluted EPS an investor must first determine basic EPS for each category on the income statement. These calculations are then ranked based on their performance. Investors find analyzing a firm’s diluted earnings per share is the better calculation because it gives a view of basic earnings per share as well as any earnings minus any convertibles and the effect of options and warrants. Conclusion It is in the best interest of firms to keep paid-in capital and earned capital separate to prevent any misrepresentation of the whereabouts of sources used for operations. Most investors are more interested in the earned capital versus paid-in capital because earned capital informs investors and shareholders of how well a firm is performing. Earned capital is worked for capital. Diluted earnings per share provided a more detailed explanation of the basic earnings per share. Using the calculation to determine earned capital shareholders and investors can identify the impact that dilutive shares may have on potential earnings. Reference Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2010). Intermediate accounting, (13th ed.). Hoboken, NJ: John Wiley & Sons.