Owner's Equity Paper

Owner’s Equity Paper

David Trejo

ACC423/Intermediate Accounting III

January 10, 2011

Facilitator: Jonathan R. Rubin, CPA

Owner’s Equity Paper

Owners’ equity is defined as capital that is derived from business operations of a corporation (Kieso, Weygandt, & Warfield, 2007). This paper will discuss the importance of separating paid-in capital from earned capital, whether paid-in or earned capital is more important to an investor, and if basic or diluted earnings per share are more important to an investor.

Paid-in Capital Separate from Earned Capital

The main reason to separate paid-in capital from earned capital is for ease in reporting. This method keeps the investment portion of capital separate from the shareholders’ segment of capital. Paid-in capital is capital derived from the share or stockholders, for business operations use. Earned capital is capital derived from the operation of the business (Kieso, Weygandt, & Warfield, 2007). Separation of paid-in and earned capital is imperative so that current and potential investors can correctly assess a corporation’s financial reports.

The Importance of Paid-in and Earned Capital

To an investor, earned capital should be more important. Earned capital indicates the amount a corporation actually earned during its business operations and is the figure that dividends will be based on. On financial statements, earned capital is reported as retained earnings. A positive figure in earned capital indicates that the corporation is profitable, making it more attractive to investors (Kieso, Weygandt, & Warfield, 2007).

Basic or diluted earnings

Diluted earnings indicate that a corporation converted options, securities, warrants, or other items convertible to common stock. Diluted earnings decrease earnings per share (Kieso, Weygandt, & Warfield, 2007). To an investor, diluted earnings would be of more interest than basic earnings. Diluted earnings increase the number of outstanding shares....