The Components of Stockholder Equity

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  • 0:01 Stockholder Equity Defined
  • 0:44 Components of…
  • 4:14 Stockholder's Equity Statement
  • 4:39 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Understanding stockholder equity is important for assessing the worth of a company from an investor's perspective. In this lesson, you'll learn about stockholder equity and its individual components.

Stockholder Equity Defined

Abby is a stockholder (or shareholder) in her family's small business, which is organized as a corporation. As a stockholder, she holds an equity interest in the company. An equity interest is just the term we use to denote a person's ownership interest in a company. Stockholder equity is the total value or net worth of a company to its shareholders.

Keep in mind we are talking about aggregate value, the value all shareholders have in the company. In Abby's case, we are talking about the net worth of the company to all the shareholders in her company; that includes not only Abby but also her brother, sister, mother, and father.

Components of Stockholder Equity

Let's take a look at the major components of stockholder equity.

Common stock is a large component of stockholder equity and is the ownership interest of shareholders representing their investment in the corporation. Common stock is usually stated at par value, which is the face value of the stock. You should note that par value is not fair market value. A stock may be worth much more (or less) than its par value. Abby, her brother, sister, mom and dad all hold common stock in the family business, though mom and dad have more shares than any of the siblings.

Preferred stock is an ownership interest in the corporation, like common stock, but preferred shareholders have priority over holders of common stock in terms of dividends (i.e., distribution of corporate earnings to the stockholders) and other distributions made to shareholders. For example, in addition to their common stock, Abby's mom and dad hold preferred stock and will be paid dividends prior to Abby and her brother and sister.

Contributed capital is also a component of stockholder equity and is the aggregate value of stock that was directly purchased from the company. We sometimes call this paid-in capital. The par value of the shares purchased is recorded under common stock or preferred stock, depending upon the type of shares, and the rest of the purchase price is recorded as contributed capital (i.e., the actual purchase price minus the par value). Let's head back to Abby's family corporation for an example.

Mom and dad contributed $250,000 to the corporation for 1,000 shares of common stock with a par value of a penny. On the company statement of shareholder equity, which we will be discussing later, we record $10 under common stock, which is the aggregate par value of the purchase, and record the remaining $249,990 as contributed capital.

Shares sold on the secondary market are not recorded as contributed capital. For example, after forming the family corporation, mom and dad decide to 'sell' 100 shares of their stock to Abby and each of their children at par value, which amounts to one dollar per child. Since this transaction was not a sale by the corporation, it is recorded in the statement of shareholder equity under common stock at its aggregate par value, which is three dollars.

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