Contributed Capital

What is Contributed Capital?

Contributed Capital is the amount that the shareholders have given to the company for buying their stake and is recorded in the books of accounts as the common stock and additional paid-in capital under the equity section of the company’s balance sheet. It is also known as the paid-in capital and the organizations records this capital from investors only in case the shares are sold to the investors directly (in the primary market).

Contributed-Capital

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Contributed Capital Formula

It is reported under the equity section of the company’s balance sheet and generally split into two different accounts which are as follows:

Contributed-Capital

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contributed Capital Formula = Common Stock + Additional Paid-in Capital

  1. Common Stock – The common stock is the par value of issued shares. The common stock of the company appears on its balance sheet below as common stock and preferred stock.
  2. Additional Paid-in Capital – The additional paid-in capital of the company represents money paid, which is paid by the shareholders of the company above the par value to the company.

Examples

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). Now, for this issue, $ 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).

Advantages

#1 – 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. It is so as it has no fixed compulsory payment requirements, which are there in case the capital is borrowed by the company in the form of regular interest payments. For this, the company pays dividends to the shareholdersDividends To The ShareholdersDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more in case of profits. However, in the case of profits as well, it is not compulsory to pay a dividend as it deferred and diverted to other business opportunities or requirements if needed for the betterment of the company.

#2 – No Collateral

For the equity shares issuedShares IssuedShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more, the investors do not ask for a pledge of collateral, which can be there if the company raises funds by borrowing the money. Also, the existing assets of the business remain free, which are then available in case required as security for loans in the future. Apart from existing assets in case, the company purchases 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 debtLong-term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability.read more in the future.

#3 – No Restrictions on Use of Funds

The main motive of the lender of funds if the company borrows the fund 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 the can generate the cash for the repayment of the loans on time. Thus the lender establishes the financial covenantsCovenantsCovenant refers to the borrower's promise to the lender, quoted on a formal debt agreement stating the former's obligations and limitations. It is a standard clause of the bond contracts and loan agreements.read more, which put restrictions on how one can use proceeds of loans. However, this restriction is not there in case of equity investors who rely on governance rights so that their interest remains protected.

Disadvantages

#1 – No Guarantee of Return

From the perspective of the investors contributed capital does not guarantee any profits, growth, or dividends to them, and their returns are more uncertain when compared with the returns received by the debt holders. Due to this risk, equity investorsEquity InvestorsAn equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc.read more expect a higher rate of return out of their investment.

#2 – 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.

Important Points

Conclusion

Contributed capital is the accounting entry on the balance sheet of the company in the form of common stock and additional paid-in capital showing the amount raised by the company by issuing the stock that has been bought by the shareholders of the company. It is the equity investmentEquity InvestmentEquity investment is the amount pooled in by the investors in the shares of the companies listed on the stock exchange for trading. The shareholders make gain from such holdings in the form of returns or increase in stock value.read more 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 the mentioned aspects will result in an increase in the equity of stockholder. Only those capital are recorded, which are sold directly to the investors of the company.

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