5. Contributed Capital

Let's talk really quickly about shareholders' equity. Now, we've already looked at this in a couple of other videos because this is part of the accounting equation. So this shareholders' equity is a part of the accounting equation, and so that's what we're looking at here is shareholders' equity. And we decided in other videos that shareholders' equity is made up itself of two parts. On the one hand, we have retained earnings, and on the other hand, we have capital stock.

And so if you break these down the middle, retained earnings on this side, we're gonna call this earned capital, if I can spell capital correctly. And then on this side, we're gonna call this contributed capital.

Now, you may be thinking to yourself, "Well, how am I supposed to remember which one's contributed capital and which one's earned capital?" Well, you look at the words. Earned. Do you remember what retained earnings is? It's net income minus dividends, gives us retained earnings. We earned our net income.

Capital stock is people bought stock. They contributed money in order to get stock. So again, it's not a matter of memorizing, it's a matter of figuring it out. We earned our net income. People gave us money to get stock. Now, I'm not gonna go too deep on the stock stuff, but you do need to know a couple of things. One is you could have two classes of stock. You could have common stock, or you could have preferred stock.

Preferred stock comes with a few benefits. It comes with, you have to pay preferred dividends before common dividends, and should the company go out of business, preferred stockholders have liquidation preferences. So when the company is selling off all its final assets, preferred stockholders get paid before common stockholders do. It's pretty easy to remember because preferred means you get preferential treatment. You get dividends before common, and you get liquidation before common. Now, one other thing I wanna touch on about stock, and you're gonna go over all of this in Chapter 11, but just real briefly, you could see, let's say you're doing a balance sheet.

At the bottom, you've got shareholders' equity, and then you've got common stock, and you're gonna see something like, let's say, $10 par. Okay, and so what in the world does $10 par mean? Well, $10 par means the common stock has a par value of $10. Now, we all know from the stock market that stocks go up and down, right? But for accounting purposes, we set a par value at $10. Let's say, it's usually set pretty low, so let's say it's set down here.

So if this is the price, it's going up and down, but for accounting purposes, the par value is set down here. Well, how do we record it when somebody buys the stock up here at $50? Well, we put $10 into the par because the par can only hold the $10. Then there's this other account called paid-in capital, and that's where we put the rest. So you see the two of these together makes the $50. Now, like I said, there's a whole chapter where you get to just talk about stock. It's exhilarating. But for now, you need to know that what goes in this par account is whatever the problem says is the par value.

And if somebody paid more than par value, in this example, they paid 50 bucks, you put the difference in this paid-in capital so that you get to the price of $50.