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Contributed Capital – Is Contributed Capital an Asset?

What Is Contributed Capital?

Contributed CapitalContributed capital is also known as paid-in capital.  It is the cash and other assets that shareholders give a company in exchange for stock. Investors make capital contributions when a company issues equity shares.  These are based on a price that shareholders are willing to pay for them. The total amount of contributed capital or paid-in-capital represents their stake or ownership in the company.  Contributed capital may also refer to a company’s balance sheet item listed under stockholders’ equity.  It often shows alongside the balance sheet entry for additional paid-in capital.  When companies repurchase shares and return capital to shareholders, the shares bought back are listed at their repurchase price.  This reduces shareholders’ equity.

In brief, contributed capital is also known as paid-in capital.  It is the cash and other assets that shareholders have given a company in exchange for stock. This is the price that shareholders paid for their stake in the company. Contributed capital is reported in the shareholder’s equity section of the balance sheet.  It usually split into two different accounts: common stock and additional paid-in capital account.

(Source: investopedia.com)

Contributed Capital – A Deeper Look

Contributed capital is the total value of the stock that shareholders have bought directly from the issuing company. It includes the money from initial public offerings (IPOs), direct listings, direct public offerings, and secondary offerings—including issues of preferred stock. It also includes the receipt of fixed assets in exchange for stock and the reduction of liability in exchange for stock.  Contributed capital can be compared with additional paid-in capital.  However, the difference between the two values will equal the premium paid by investors over and above the par value of the company’s shares. The par value is merely an accounting value of each of the shares to be offered.  It is not equivalent to the market value that investors are willing to pay.

Preferred shares sometimes have par values that are more than marginal, but most common shares today have par values of just a few pennies. Because of this, “additional paid-in capital” tends to be representative of the total paid-in capital figure and is sometimes shown by itself on the balance sheet. 

Contributed capital is an element of the total amount of equity recorded by an organization. It can be a separate account within the stockholders’ equity section of the balance sheet.  Or, it can be split between an additional paid-in capital account and a common stock account. In the latter case, the par value of the shares sold is recorded in the common stock account.  Any excess payments are recorded in the additional paid-in capital account. It is customary for investors to concentrate their attention on the net amount of total equity, rather than this single element of equity. Thus, the recording of contributed capital is designed to fulfill a legal or accounting requirement.  Rather than providing additional useful information.

Contributed Capital vs Capital Contributions

It’s important to distinguish that capital contributions are an injection of cash into a company.  And, they can come in other forms besides the sale of equity shares. For example, an owner might take out a loan and use the proceeds to make a capital contribution to the company. Businesses can also receive capital contributions in the form of non-cash assets such as buildings and equipment. These scenarios are all types of capital contributions and increase owners’ equity. However, the term contributed capital is typically reserved for the amount of money received from issuing shares and not other forms of capital contributions.

(Source: ibid & accountingtools.com)

What is Additional Paid-in Capital?

Additional paid-in capital is the amount paid for share capital above its par value. It is also commonly known as the “contributed capital in excess of “par” or “share premium.” Essentially, the additional paid-in capital reveals how much money investors paid for the shares above their nominal value.

Additional paid-in capital is recorded on a company’s balance sheet under the stockholders’ equity section. The account for the additional paid-in capital is created every time when a company issues new shares to or repurchases its shares from shareholders. Note that the transactions with the company’s shares in the secondary market do not affect the company’s paid-in capital since it does not receive any cash for the transactions.

Remember that the par value of a stock is usually a small amount (e.g., $0.10 or $0.01) that appears on stock certificates. In some cases, the par value can even be lower than $0.01. The par value must not be confused with the market value of shares. Par value indicates the minimum value at which a company may sell its shares to investors. On the other hand, the market value of shares is determined by the transactions occurring in the market.

(Source: corporatefinanceinstitute.com)

Calculating Contributed Capital

Contributed capital is reported in the shareholder’s equity section of the balance sheet.  It is usually split into two different accounts: common stock and additional paid-in capital account. In other words, contributed capital includes the par value—or nominal value—of the stock, found in the common stock account, and the amount of money over and above the par value that shareholders were willing to pay for their shares—the share premium—found in the additional paid-in capital account. The common stock account is also known as a share capital account.  The additional paid-in capital account is also known as the share premium account.

How to Increase Contributed Capital

Every time an investor acquires shares from a company, they are recorded in the balance sheet as paid-in capital. Can an investor increase their shares? Yes. They can and there are several ways of doing so.

  • Issuance of Preferred Shares: – This happens when a company is not in a position to issue additional common stock.  Perhaps, because the market is not doing well and the equity value is not strong. Consequently, the issuance of preferred shares is likely to increase the paid-in capital.
  • Issuance of New Shares: – Shares are issued to investors during the founding of a company. The investors purchase common class stock shares.  These are entered as a new journal and recorded at par value. However, the company may also decide to seek more financing for a new project.  As a result, they put new shares on sale for investors. At this point, a new journal is opened and adjusted upwards to accommodate the new shares in the balance sheet. The new shares increase the aid-in capital in the balance sheet.
  • Capital Structure: – Differences between equity and debt are likely to influence the status of the capital structure. When optimal structure increases more than the capital structure, debt financing is affected.  This, in turn, affects common and preferred shares. In the long run, the total paid-in capital is also impacted.

(Source: stockmaster.com)

Contributed Capital Examples

For example, a company issues 20,000 $1 par value shares to investors. The investors pay $10 a share, so the company raises $200,000 in equity capital. As a result, the company records $20,000 to the common stock account and $180,000 to the paid-in capital in excess of par. Both of these accounts added together equal the total amount stockholders were willing to pay for their shares. In other words, the contributed capital equals $200,000 ($20,000 + $180,000).

Example 2

Company X ltd issued 1,000 common stocks to the investors at the par value of $ 10 each. However, as per the requirement and terms and conditions of the issue of shares, the investors have to pay $ 100,000 for these shares. The shares were fully subscribed, and the investors paid $ 100,000 for these shares having the par value of $ 10,000 (1,000 shares * $ 10). Therefore, $ 10,000 (being par value) will be recorded by the company in common stock accounts, and the additional $ 90,000 ($ 100,000 – $ 10,000) will be recorded to paid-in capital as this amount is in excess of the par value of shares. Total contributed capital will be the sum of both of these accounts, i.e., a sum of common stock accounts and the paid-in capital accounts, which will be equal to $ 100,000 ($ 90,000 + $ 10,000).

(Source: wallstreetmojo.com)

Advantages

No Fixed Payment Burden

The amount received in the form of contributed capital does not increase the fixed cost or the fixed payment burden of the company. This is because it has no fixed compulsory payment requirements.  However, if the capital is borrowed by the company as debt, regular interest payments must be made. For this, the company pays dividends to the shareholders in case of profits. However, it is not compulsory to pay a dividend as it can be deferred and diverted to other business opportunities or requirements if needed for the betterment of the company.

No Collateral

For the equity shares issued, the investors do not ask for a pledge of collateral.  However, this requirement may exist if the company raises funds by borrowing the money. Also, the existing assets of the business remain free.  They are then available in case they are required as security for loans in the future. Apart from existing assets, the company can purchase new assets with the funds raised through the issue of equity capital.  Then it can also be used by the company for securing its long-term debt in the future.

No Restrictions on Use of Funds

The main motive of a lender of funds is on the repayment of debt and interest portion on time. So, a lender wants to make sure that the proceeds of the loan are used in areas where they can generate the cash for the repayment. Thus the lender establishes financial covenants, which put restrictions on how borrowers can use proceeds of loans. However, these restrictions are not there in the case of equity investors.  Instead, they rely on governance rights so that their interest remains protected.

Disadvantages

No Guarantee of Return

From the perspective of the investors contributed capital does not guarantee any profits, growth, or dividends to them.  Their returns are more uncertain when compared with the returns received by the debt holders. Due to this risk, equity investors expect a higher rate of return out of their investment.

Dilution of Ownership

Equity investors have governance rights with respect to the election of a board of directors and the approval of many major business decisions of the company. This right leads to the dilution of ownership and control and increases in the oversight of the management decisions.

(Source: ibid)

Conclusion

Contributed capital is an accounting entry on the balance sheet of the company.  It represents the common stock and additional paid-in capital purchased by investors.  It shows the amount raised by the company through issuing stock that is now owned by the shareholders of the company. Therefore, it is an equity investment made by shareholders in a company. Stock can be bought by the shareholders by paying the cash or in exchange for the fixed assets in the company. Also, it is possible to acquire the stock of the company in exchange for the reduction in the company’s debt. Each of these methods will result in an increase in the equity of stockholders.

The shareholders’ equity section of the balance sheet also contains related amounts.  These are called additional paid-in capital and contributed capital. The key difference between additional paid-in capital vs. contributed capital is that the latter is referred to as the total value of cash and assets that shareholders provided to a company in exchange for the company’s shares. Additional paid-in capital refers to the value of cash or assets that the shareholders provided over and above the par value of the company’s shares.  Additional paid-in capital and contributed capital are reported differently on the balance sheet under the shareholders’ equity section. The additional paid-in capital is reported in a separate account. Whereas, contributed capital is combined and is the sum of the common stock and additional paid-in capital accounts.

(Source: ibid & corporatefinanceinstitute.com)

Up Next: Day Trading For Beginners – What Is A Day Trader

Day trading is simply buying a stock or security, then, quickly selling or closing out the position.  Usually, the position is closed within a single trading day.  Ideally, a day trader wants to “cash-out” by the end of each trading day.  They want no open positions to avoid the risk of losses by holding security overnight.  Day trading is not for everyone and carries significant risks. It requires an in-depth understanding of how the markets work and various strategies for profiting in the short term.  Short term profits require a very different approach compared to traditional long term, buy and hold investment strategies.

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