Stockholders' Equity: Classes of Capital Stock

The corporation

Balance sheet presentation of stock

The stockholders' equity section of a corporation's balance sheet contains two main elements: paid-in capital and retained earnings. Paid-in capital is the part of stockholders' equity that normally results from cash or other assets invested by owners. Paid-in capital also results from services performed for the corporation in exchange for capital stock and from certain other transactions discussed in Chapter 13. As stated earlier, retained earnings is the part of stockholders' equity resulting from accumulated net income, reduced by dividends and net losses. Net income increases the Retained Earnings account balance and net losses decrease it. In addition, dividends declared to stockholders decrease Retained Earnings. Since Retained Earnings is a stockholders' equity account and represents accumulated net income retained by the company, it normally has a credit balance. We discuss retained earnings in more detail in Chapter 13.

The following illustration shows the proper financial reporting for preferred and common stock. Assume that a corporation is authorized to issue 10,000 shares of USD 100 par value, 6 percent, cumulative, convertible preferred stock (five common for one preferred), all of which have been issued and are outstanding; and 200,000 shares of USD 10 par value common stock, of which 80,000 shares are issued and outstanding. The stockholders' equity section of the balance sheet (assuming USD 450,000 of retained earnings) is:

Stockholders' equity:
Paid-in capital:
Preferred stock – USD 100 par value, 6 percent cumulative, convertible (5 common for 1 preferred); authorized, issued, and outstanding, 10,000 shares $ 1,000,000
Common stock – USD 10 par value; authorized, 200,000 shares; issued and outstanding 80,000 shares 800,000
Total paid-in capital $ 1,800,000
Retained earnings 450,000
Total stockholders' equity 2,250,000

Notice that the balance sheet lists preferred stock before common stock because the preferred stock is preferred as to dividends, assets, or both. The company discloses the conversion rate in a parenthetical note within the description of preferred stock or in a footnote.

An accounting perspective:

Business insight

WHX corporation in its 1999 annual report provided the following presentation of preferred stock in the stockholders' equity second of its balance sheet:

Stockholders' equity:
Preferred stock – $.10 par value: authorized 10,000 shares;
issued and outstanding: 5,883 shares