Question

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

Answer 1

Part 1

Difference between Paid in capital and Retained earnings

Paid in capital	Retained earnings
Paid in capital is amount of shareholder’s equity that is contributed by the owners of the business in form of cash or otherwise*.	Retained earnings on the other hand is the sum total of Earnings of the business over the years minus dividends paid.
Paid in capital increases only when new cash is brought in by the shareholders or in special circumstances such as merger or acquisition.	Retained earnings increase when profits are earned. It decreases with loss and when Dividends paid are more than income in a year.
Generally common stocks or preferred stocks are issued when capital is added to paid in capital.	Retained earnings stays in the books and does not issue shareholders any such documents.
Paid in capital is not an earned money but only an invested money.	Retained earnings is an earned money.
Dividends are not paid out of paid in capital	Dividends are paid out of retained earnings.

*Here otherwise means contribution by bringing a machine or other asset.

Part 2

Major transactions that impact the amount of paid in capital are

1. Buy back of shares by company in open market.
2. Issue of new shares.
3. Distribution of Stock Dividends.
4. Retirement of securities.

Part 3

Major activities	Effect of activities on paid in capital balance
Buy back of shares by company in open market.	Decrease
Issue of new shares.	Increase
Distribution of Stock Dividends.	Increase
Retirement of securities.	Decrease