Why is it important to keep paid-in capital separate from earned capital?
As an investor, is paid-in capital or earned capital more important? Explain why.
As an investor, are basic or diluted earnings per share more important? Explain why.
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Paid-in Capital and Earned Capital in Books
A company generates capital from the shareholders in two ways that is invested capital and earned capital. Invested capital is the amount that is invested by an investor through buying the capital stock of a particular company. On the other hand, earned capital is the excess amount of profit that is earned by the shareholders and remains in the business after distributing dividend for reinvestment purpose (Norton, Diamond & Pagach, 2006). Paid in capital and retained earnings (Earned capital) both are the different section of shareholder's equity in balance sheet. This difference is important from both economic and a legal point of view. To keep them separate is important for a business as paid-in capital is earned by the sale of capital stock, while earned capital is the result of profitable business operations (Pratt, 2010).
Another reason to keep them separate is that paid-in capital represents the amount of stockholder that shows par value of company's stock that has issued. On the other hand, retained earning represents earnings of an organization after distribution of dividend to their shareholders. It represents only the amount that is generated by firm through its operation (Kimmel, Weygandt & Kieso, 2008). Company is also legally bound to show both in different section as per the generally accepted accounting principles. It is because through keeping these accounts separate in books, investors and management of the organization will be enabled to determine capital stock and structure and also earning on stock. If paid-in capital and earned capital will not ...
This solution discusses paid-in capital, earned capital, basic earnings per share and diluted earnings per share.