Question a: Stockholder’s Equity

Stockholder’s equity refers to the difference between liabilities and assets and when positive, it indicates that the business is valuable (Wang & Williams, 2011). There are five subdivisions listed in the equity section of an organizational balance sheet such as common stock, preferred stock, treasury stock, retained earnings, and additional paid-in capital.

Paid-in capital is the total amount an owner invests in the business (Businss, 2012). It is represented by the difference the stock par value and the amount of money accumulated from the stock sale. For instance, the recorded paid in capital is $9 if common stock share with a par value of $1 is sold for $10. Retained earnings, on the other hand, refers to the total net income earned by the firm which has accumulated over a prolonged period of time. For example, if a business entity incorporated in the year 2010 with a net income of $ 100,000 and $200,000 in 2011 but did not distribute dividends, the balance sheet at the end of 2011 financial year would indicate retained earnings as $300,000.

Treasury stock is the difference between the number of shares sold by a company and the issued shares. In this section of the balance sheet, treasury stock par value, total authorized shares, and the number of outstanding shares are included. Contrastingly, common stocks represent the company’s ownership. Therefore, this section includes common stock par value, outstanding and authorized shares. Lastly, the preferred stock has fixed dividends payable before common stock. The section will include preferred stock par value, issued shares, and outstanding shares.

Question b: Reasons for Subdivisions

            Stockholder’s equity is subdivided because of business creditors. Business laws in most developed countries protect creditors through the establishment of the legal capital concept, which implies to the net amount of assets non-distributable to the stockholders (Libby et al., 2011). Because of this, there is a need for accountants to report the legal capital separately from the shareholder’s investments. Worth noting is that the outstanding shares’ stated or par value in most cases constitute the legal capital of the organization. Still, there are particular kinds of transactions that lead permanent or paid-in capital in excess of legal capital. For example, if the stock is sold at par value, it must be classified as an added paid-in capital.

Question c: Transactions

There are numerous kinds of transactions that lead to permanent capital in excess of stated capital. First, the debt to this account results from liquidating dividends transaction. The liquidating dividend is a payment made by the business entity to the stockholders during partial business liquidation (Dooley, 2011). Often, the amount is not taxable and is conducted using the firm’s capital base.  Second, permanent capital is a product of treasury stock sold below the standard cost. The proceedings, therefore, are debited to ‘Cash’ while the cost of sold shares is credited to the ‘Treasury Stock’ section. Resultantly, the difference between the two is posted as paid-in stock. Third, the capital stock is issued at a premium particularly if the share’s selling cost is higher than the par value. Hence, the amount of premium is the difference between the selling price of the shares and their par-value. Premium is often attainable since the par value is set at a particular value, for instance, $0.001 per share.

Question d: Surplus

The use of the term surplus in business financial statements is discouraged because it does not always imply the excess of assets such as incomes capital or profit (Seward, 2013). There are some instances where surplus refers to a negative outcome, especially when the transactions involve inventories. The use of this term is mainly because of its technicality and ease of understanding among the accountants.  The acceptable substitutes for earned surplus include retained earnings, accumulated earnings, or retained capital. On the other hand, the recommended term for ‘paid-in surplus’ is paid-in capital (Brief &Peasnell, 2013).

References

Business, D. (2012). About Doing Business. The World Bank. 2012a. http://www. doingbusiness. org/about—us.

Dooley, M. P. (1996). A Survey of Literature on Controls over International Capital Transactions. Staff Papers, 43(4), 639-687.

Libby, R., Libby, P. A., & Short, D. G. (2001). Financial Accounting. McGraw-Hill/Irwin.

Seward, G. C. (2013). Earned Surplus--Its Meaning and Use in the Model Business Corporation Act. Va. L. Rev., 38, 435.

Wang, Z., & Williams, T. H. (2011). Accounting Income Smoothing and Stockholder Wealth. Journal of Applied Business Research (JABR), 10(3), 96-104.