Question

Early in 2014, Jones Industries was formed with authorization to issue 125,000 shares of $20 par value common stock and 15,000 shares of $100 par value cumulative preferred stock.  During 2014, all the preferred stock was issued at par, and 90,000 shares of common stock were sold for $35 per share.  The preferred stock is entitled to a dividend equal to 5 percent of its par value before any dividends are paid on the common stock.

During its first five years of business (2014 through 2018), the company earned income totaling $3,850,000 and paid dividends of 55 cents per share each year on the common stock outstanding.  

On January 2, 2016, the company purchased 2,000 shares of its own common stock in the open market for $80,000.  On January 2, 2018, it reissued 1,200 shares of this treasury stock for $60,000. The remaining 800 shares were still held in treasury at December 31, 2018.

1. Distinguish between paid-in capital and retained earnings of a corporation.  Why is such a distinction useful?
   1. What are the major transactions and other financial activities that impact the amount of paid-in capital of a corporation?
   2. Identify for each major type of transaction or activity whether it increasesor decreasesthe amount of paid-in-capital.

Answer 1

Paid in capital vs Retained Earnings

Paid in capital, in general, represents that amount that a company receives in exchange of issue of shares. On the other hand, retained earnings is the amount that the company has earned over the years of its operations net of any dividends paid to the shareholders.
In case of losses, the retained earnings balance can be NEGATIVE or it shows a deficit. Paid in capital will generally always be positive.

Retained earnings can help a company in cases of expansion or buying new assets. It can be an internal source of financing its plans. It also helps in making the shareholders happy by declaring interim dividend and giving out stock dividends.
Distinction is necessary because in the absence of it, a company making losses won't show a correct picture and the board will not be able to decide its financing options if retained earnings balance was not separately known.

The major transactions and other financial activities that impact the amount of paid in capital are as follows
1. Issue of new shares
2. Sale of treasury stock
3. Retirement of treasury stock
4. Bonus shares
5. Issuance of new preferred stock

a. Issue of common stock INCREASES the amount of paid in capital
b. Issue of preferred stock INCREASES the amount of paid in capital
c. Bonus shares INCREASES the amount of paid in capital. It reduces retained earnings
d. Issue of treasury stock at price more than par value INCREASE amount of paid in capital
e. Retirement of treasury stock DECREASES the amount of paid in capital