A corporation’s success is important to the investors. There are many ways to define the success of the corporation, from longevity to the financial statements. Investors pay attention to certain aspects of financial statements when making a decision to purchase stock. Investors are aware of a corporation’s paid-in capital, earned capital, basic earnings, and diluted earnings. Understanding the roles of these aspects of a company’s financial position and ability to pay dividends becomes a focus of an investor’s final decision to purchase stock.
Paid-in Capital vs. Earned Capital
It is important to keep paid-in capital separate from earned capital because they represent two different types of capital. One is based on earnings while the other is composed of the purchase of stock. Kieso, Weygandt, and Warfield (2012) defined “earned capital is capital that develops from profitable operations” and paid-in capital as “the total amount paid in on capital stock—the amount provided by stockholders to the corporation for use in the business” (p. 846). The two types of capital help distinguish how well the business is performing and where the business obtains assistance to expand or maintain operations. Dividends are paid from the earned capital. This type of capital is important in determining whether an organization can grow or generate income. It is important paid-in capital remains separate from earned capital because paid-in capital is the extra obtained from selling stocks. The separation of earned capital and paid-in capital is important because internal and external users rely on the information to determine the financial health of an organization.
Investors are external users who rely on the separation of earned capital and paid-in capital. Both types of capital are important to investors for different reasons. However, investors may rely on information from both equally. Without information about paid-in capital, an...