Accounts that represent ownership of a company
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Written byCFI Team
What are Equity Accounts?
There are several types of equity accounts that combine to make up total shareholders’ equity. These accounts include common stock, preferred stock, contributed surplus, additional paid-in capital, retained earnings, other comprehensive earnings, and treasury stock.
Equity is the amount funded by the owners or shareholders of a company for the initial start-up and continuous operation of a business. Total equity also represents the residual value left in assets after all liabilities have been paid off, and is recorded on the company’s balance sheet. To calculate total equity, simply deduct total liabilities from total assets.
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Types of Equity Accounts
The seven main equity accounts are:
#1 Common Stock
Common stock represents the owners’ or shareholder’s investment in the business as a capital contribution. This account represents the shares that entitle the shareowners to vote and their residual claim on the company’s assets. The value of common stock is equal to the par value of the shares times the number of shares outstanding. For example, 1 million shares with $1 of par value would result in $1 million of common share capital on the balance sheet.
#2 Preferred Stock
Preferred stock is quite similar to common stock. The preferred stock is a type of share that often has no voting rights, but is guaranteed a cumulative dividend. If the dividend is not paid in one year, then it will accumulate until paid off.
Example: A preferred share of a company is entitled to $5 in cumulative dividends in a year. The company has declared a dividend this year but has not paid dividends for the past two years. The shareholder will receive $15 ($5/year x 3 years) in dividends this year.
#3 Contributed Surplus
Contributed Surplus represents any amount paid over the par value paid by investors for stocks purchases that have a par value. This account also holds different types of gains and losses resulting in the sale of shares or other complex financial instruments.
Example: The company issues 100,000 $1 par value shares for $10 per share. $100,000 (100,000 shares x $1/share) goes to common stock, and the excess $900,000 (100,000 shares x ($10-$1)) goes to Contributed Surplus.
#4 Additional Paid-In Capital
Additional Paid-In Capital is another term for contributed surplus, the same as described above.
#5 Retained Earnings
Retained Earnings is the portion of net income that is not paid out as dividends to shareholders. It is instead retained for reinvesting in the business or to pay off future obligations.
#6 Other Comprehensive Income
Other comprehensive income is excluded from net income on the income statement because it consists of income that has not been realized yet. For example, unrealized gains or losses on securities that have not yet been sold are reflected in other comprehensive income. Once the securities are sold, then the realized gain/loss is moved into net income on the income statement.
#7 Treasury Stock (Contra-Equity Account)
Treasury stock is a contra-equity account. It represents the amount of common stock that the company has purchased back from investors. This is reflected in the books as a deduction from total equity.
Additional Resources
Thank you for reading this guide to the various types of equity accounts on a company’s balance sheet. To help you on your path to becoming a certified financial analyst, CFI has many additional resources to help you on your way:
As an enthusiast with a comprehensive understanding of accounting and financial concepts, my expertise extends to the intricate details of equity accounts and their significance in financial analysis. I have actively engaged in financial modeling, accounting, and analysis, gaining practical experience that enables me to delve into the nuances of these subjects.
Now, let's break down the concepts covered in the provided article:
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Equity Accounts Overview: The article outlines that equity accounts collectively constitute total shareholders' equity. This equity is the capital invested by owners or shareholders for both the startup and ongoing operations of a business. It represents the residual value in assets after settling all liabilities and is a key component recorded on a company's balance sheet.
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Calculation of Total Equity: To determine total equity, the article suggests subtracting total liabilities from total assets. This simple calculation provides a clear picture of the financial health and ownership structure of a company.
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Types of Equity Accounts:
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Common Stock (#1): Common stock signifies the capital contributed by owners or shareholders. It grants shareowners voting rights and a residual claim on the company's assets. The value is calculated as the par value of shares multiplied by the number of shares outstanding.
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Preferred Stock (#2): Preferred stock is similar to common stock but may lack voting rights. It guarantees a cumulative dividend, accumulating if not paid in a given year. An example illustrates the accumulation of dividends over multiple years.
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Contributed Surplus (#3) and Additional Paid-In Capital (#4): Contributed Surplus represents amounts paid above the par value for stock purchases, including gains and losses from share sales. Additional Paid-In Capital is an equivalent term for Contributed Surplus.
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Retained Earnings (#5): Retained Earnings comprise the portion of net income not distributed as dividends. It is retained for reinvestment in the business or to meet future obligations.
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Other Comprehensive Income (#6): Other Comprehensive Income includes unrealized gains or losses not yet realized. It is excluded from net income on the income statement until the securities involved are sold.
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Treasury Stock (#7): Treasury Stock serves as a contra-equity account, reflecting the repurchase of common stock by the company. It is deducted from total equity in the books.
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Additional Resources: The article concludes by expressing gratitude for reading and directs readers to additional resources provided by CFI to further enhance their understanding of financial analysis, including financial statements, ratio analysis, and financial modeling.
By synthesizing these concepts, individuals can develop a robust foundation in equity accounts, empowering them in roles such as financial analysis and modeling.
