Owners’ equity is simply defined as capital that is employed in a company, which is computed by subtracting the book value of its liabilities from the book value of its assets. In this paper we will touch on three areas of importance in dealing with owners’ equity. First we will talk about why it is important to keep paid in capital separate from earned capital. Next we will look from an investor’s point of view and debate on the question of, is paid in capital more important than earned capital? Lastly again from the investors point of view we will look at the higher importance of either basic or diluted earnings per share.
To sufficiently answer the question of why it is important to keep paid in capital separate from earned capital, we can look at the fact that this needs to happen because they represent two distinctive and different funding sources. The combination of both will end up misrepresenting the total earning potential from operations. To explain even further we see that pain in capital represents funds that are new and are intended to help the company increase their earned capital. Now earned capital looks at a company’s profits from their operations. Another way of analyzing these two is by stating that earned capital comes from the profits of the company and paid in capital is coming from the investors.
Moving on slightly with the difference between paid in capital and earned capital we look to see, as an investor, which one is more important. To a company and to all its counterparts it is always more important to earn money from operations first. Although earning money from investors can create revenue, it does not initially show the full earning potential and future stability of the company on its own. Showing earned capital to investors paints a picture of a confident investment and will be more attractive to all analysts. Showing an excess of paid in capital will show the opposite to an investor and perceive the
References: Jacobsen, Wachterhauser (2010). Keeping Paid-in Capital Separate from Earned Capital. Retrieved on February 16, 2013 from: http://www.phxaccountant.com/keeping-paid-in-capital-separate-from-earned-capital/2010/05/. KIESO, D. E. PH.D., C.P.A. WEYGANDT, J. J. PH.D., C.P.A. WARFIELD, T. D. PH.D. (2010) Intermediate Accounting. John Wiley & Sons, Inc.