Notes

Stockholder equity refers to the monetary value of a company to those who have stock in it. Study the definition and the components of stockholder equity, and the stockholder's equity statement.
Stockholder Equity Defined
Abby is a stockholder (or shareholder) in her family's small business, which is organized as a corporation. As a stockholder, she holds an equity interest in the company. An equity interest is just the term we use to denote a person's ownership interest in a company. Stockholder equity is the total value or net worth of a company to its shareholders.

Keep in mind we are talking about aggregate value, the value all shareholders have in the company. In Abby's case, we are talking about the net worth of the company to all the shareholders in her company; that includes not only Abby but also her brother, sister, mother, and father.

Components of Stockholder Equity
Let's take a look at the major components of stockholder equity.

Common stock is a large component of stockholder equity and is the ownership interest of shareholders representing their investment in the corporation. Common stock is usually stated at par value, which is the face value of the stock. You should note that par value is not fair market value. A stock may be worth much more (or less) than its par value. Abby, her brother, sister, mom and dad all hold common stock in the family business, though mom and dad have more shares than any of the siblings.

Preferred stock is an ownership interest in the corporation, like common stock, but preferred shareholders have priority over holders of common stock in terms of dividends (i.e., distribution of corporate earnings to the stockholders) and other distributions made to shareholders. For example, in addition to their common stock, Abby's mom and dad hold preferred stock and will be paid dividends prior to Abby and her brother and sister.

Contributed capital is also a component of stockholder equity and is the aggregate value of stock that was directly purchased from the company. We sometimes call this paid-in capital. The par value of the shares purchased is recorded under common stock or preferred stock, depending upon the type of shares, and the rest of the purchase price is recorded as contributed capital (i.e., the actual purchase price minus the par value). Let's head back to Abby's family corporation for an example.

Mom and dad contributed $250,000 to the corporation for 1,000 shares of common stock with a par value of a penny. On the company statement of shareholder equity, which we will be discussing later, we record $10 under common stock, which is the aggregate par value of the purchase, and record the remaining $249,990 as contributed capital.

Shares sold on the secondary market are not recorded as contributed capital. For example, after forming the family corporation, mom and dad decide to 'sell' 100 shares of their stock to Abby and each of their children at par value, which amounts to one dollar per child. Since this transaction was not a sale by the corporation, it is recorded in the statement of shareholder equity under common stock at its aggregate par value, which is three dollars.

Retained earnings are also included in stockholder equity. Retained earnings are simply the net income or loss that the corporation generates minus any distribution of dividends to stockholders since the corporation was formed. You can think of retained earnings as income that accumulates over time and is not distributed out to stockholders as their personal profit. For example, let's say that in 2014 Abby's company had $100,000 in retained earnings. The company earned a net income of $125,000 in 2015, but distributed $100,000 as dividends to Abby and the other shareholders. The retained earnings are $125,000.

Treasury stock is stock that the company has purchased back from its stockholders. Stockholder equity decreases when a corporation repurchases its stock to the extent it uses its retained earnings to pay for the stock.

Keep in mind that we just discussed some key components of stockholder equity. There may be other components that are added under differing circumstances. Examples include such things as a valuation allowance and cumulative translation allowance. We don't need to explore these concepts in this lesson, but you should note that the basic components we discussed may be supplemented and often recorded under a general 'other' category in a statement of stockholder equity.

Stockholder's Equity Statement
Stockholder's equity is recorded on the company's balance sheet (i.e., a statement of the company's assets, liability, and owner's equity at a particular point in time). Some companies will pull out these numbers from the balance sheet in a separate financial document called a stockholder's equity statement. This statement shows the changes to each component of stockholder equity through the period covered in the report and the total current value as of the reporting date.

Lesson Summary
Let's review what we've learned. Stockholder equity is the total value or net worth of a company to its shareholders. Major components of stockholder equity include common stock, preferred stock, retained earnings, and treasury stock.

Stockholder's equity is recorded on the company's balance sheet and may be reported separately in a stockholder's equity statement.