Accounting
What is Contributed Capital?
Contributed capital is the amount of money that shareholders invest in a corporation in exchange for newly issued shares of stock. Another name for contributed capital is “paid-in capital” because capital is paid in exchange for company ownership.
Understanding Contributed Capital
When corporations are looking to raise capital, they can do so in one of three ways: They can issue debt (by taking out a loan), Accept capital from existing shareholders, or issue new shares of stock. Contributed capital refers to the capital raised in this third scenario with the issuance of new stock shares.
Most shareholders purchase newly issued stock with cash, but you can buy stock with assets, too. This includes tangible assets like land, buildings, and equipment, and it also includes intangible assets like patents or trademarks.
How is Contributed Capital Calculated?
Contributed capital is easy to calculate when someone uses cash to purchase stock. It’s simply the total amount of money the buyer paid in. If someone uses non-cash assets to buy stock shares, their contributed capital is the fair market value of those assets at the time of the exchange.
Contributed capital will be reflected in the stockholders’ equity section of the company’s balance sheet. Still, it will be split into two different accounts: Common or preferred stock, and additional paid-in capital (sometimes abbreviated as APIC). The amount of contributed capital representing the par value of the stock shares will be reported as common or preferred stock. Everything in excess of par that remains will be recorded as additional paid-in capital.
You may be wondering: Why is there a discrepancy between par value and fair market value of stock shares? A Par value is an arbitrary number set by the issuing corporation. When the stock is originated, the corporation assigns a par value to all current and future stock shares. Most companies assign very low par values — one dollar or even one cent. They do this because legally, if their share price drops below its par value, the company may be required to compensate investors for the difference. Keeping par values low ensures this will seldom happen.
Because par values tend to be so low, most contributed capital will be dumped into the APIC bucket. If you want to know the actual book value of shareholders’ equity, you must combine the common stock account and the additional paid-in capital accounts.
Example of Contributed Capital
To understand how contributed capital is recorded on the balance sheet, let’s look at an example.
Example 1:
Company A wants to raise capital by issuing 2,000 new shares of common stock. Par value is $1 per share, and on the date of issuance, the fair market value of each share is $25. Selling all 2,000 newly issued shares would raise $50,000 in new capital for the business.
The company should record $50,000 of contributed capital, split into two separate buckets:
Common Stock $2,000
2,000 shares x $1 par value
Additional Paid-in Capital $48,000
$25 fair value per share x 2,000 shares less par value of shares
Other Important Things to Understand About Contributed Capital
Contributed capital is a unique concept, so here are a few other important things to remember.
Contributed capital is only a portion of shareholders’ equity.
Contributed capital is a broad term and can include funds raised from:
- The issuance of both common and preferred stock
- Initial public offerings (IPO)
- Shares sold on a public marketplace
- Secondary share offerings to existing shareholders
But contributed capital does not encompass all equity transactions. Net income, net losses, and stock buybacks will increase or decrease the owner’s equity but will not change contributed capital.
Changes in share value won’t affect contributed capital already recorded on the financial statements.
The capital contribution values on the balance sheet will stay the same even if the company’s share price grows. Only new stock issuances would change the value of common stock and APIC. For a refresher, here’s a handy reference on financial reporting.
Stock buybacks won’t necessarily reduce contributed capital.
Sometimes, companies initiate stock buybacks. They may do this to:
- Reward investors by returning company wealth back to them
- Increase the stock value of remaining shares
- Invest in themself when they believe the market is undervaluing their shares
Stock buybacks will not, on their own, affect contributed capital. Instead, repurchased shares will be posted to treasury stock, which reduces overall shareholders’ equity but helps preserve the contributed capital balance. Let’s look at an example:
Example 2:
At the beginning of the year, Company A’s shareholders’ equity section looks like this:
| Contributed Capital | |
| Common Stock, $1 par value | $2,000 |
| Additional Paid-In Capital | $48,000 |
| Total Contributed Capital | $50,000 |
| Retained Earnings | $10,000 |
| Less: Treasury Stock | — |
| Total Shareholders’ Equity | $60,000 |
The company wants to repurchase 100 shares, now selling for $40. They would record a journal entry with a $400 debit to treasury stock and a $400 credit to reflect that cash repurchase. The company’s shareholders’ equity section would look like after the stock buyback.
| Contributed Capital | |
| Common Stock, $1 par value | $2,000 |
| Additional Paid-In Capital | $48,000 |
| Total Contributed Capital | $50,000 |
| Retained Earnings | $10,000 |
| Less: Treasury Stock (100 shares x $40) | ($400) |
| Total Shareholders’ Equity | $59,600 |
The contributed capital balance remains the same as it was before the buyback.
Pros and Cons of Contributed Capital
Contributed capital can benefit the company, but it also has its downsides.
Pros of Contributed Capital
- The company gets to keep those funds indefinitely.
Unlike a loan, which must be repaid, capital contributions remain with the company permanently.
- The company can use those funds indiscriminately.
There is no obligation to use contributed capital for any one purpose.
- Companies that don’t qualify for debt financing can still accept contributed capital.
Companies with bad credit, operate in risk-heavy industries, have no collateral, or otherwise struggle to be approved for a loan can still raise equity by issuing stock.
- No maintenance payments are required.
If companies seek debt financing, they know they will be required to make monthly payments on that debt. Though some corporations pay distributions to equity investors, dividends are always discretionary, making them an excellent option for companies low on cash reserves or companies with unpredictable cash flows.
Cons of Contributed Capital
- Contributed capital dilutes existing owners’ shares.
Existing owners may be unhappy if their corporation issues stock to new investors because it would dilute their ownership percentage and the total value of their capital account.
- Contributed capital is more expensive than debt financing.
The cost of equity is almost always more expensive than the cost of debt because the risk to equity owners is much higher than the risk to creditors.
- It can be difficult to find new quality shareholders.
Many corporations, especially corporations with few shareholders or corporations that maintain tight control over voting stock, won’t accept just any investor off the street; they will want an investor who will help support the current owners’ goals for the business. Finding a good fit could be difficult. So if you need capital quickly, equity financing might not be the best option.
- Calculating the share price is not always easy.
If your company’s shares are not traded on the open market, you will need to get your company valued by a professional to know how to value each share of stock, which can be costly and time consuming.
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