Updated July 18, 2023
What is Contributed Capital?
Contributed Capital is defined as the capital which are in the form of liquid assets and cash as given by the shareholders in return of the ownership of the stock. They are also regarded as paid-in capital.
Explanation
Investors who generally make contributions of capital, take up the equity issues in return. The shareholders here purchase the stock basis the price quoted for each stock by the business. Investors, therefore, make contributions of capital if they are willing to purchase the stock at the price quoted by the business.
The contributed capital is present in the balance sheet under stockholder’s equity and it is present besides the balance sheet entry for the additional paid-in capital. The business records such type of capital when the share is sold to the investors by utilizing the primary market.
How to Calculate Contributed Capital?
The contributed capital is calculated as the sum of the value of the common stock that the business issued and the additional paid in capital. It is represented as per the formula described below: –
The first step to determine the contributed capital would be to determine the effective par value of the stock. This is the amount that the business would quote to the investors when going to the financial market. The next step would be the determination of additional paid-in capital which the investors normally pay over and above the par value of the common stock to the business. As the last step, the contributed capital would be determined as the sum of the common stock and the additional paid-in capital.
Example of Contributed Capital
Suppose the business issued 1,000 common stock having a price of $10 per share. When the business went to the primary market, the business was able to procure $120,000 on the issuance of the stock. Help the management determine the additional paid in capital and contributed capital.
Solution:
Management raised $120,000 from the primary market. This amount would be regarded as the contributed capital of the business. The additional paid in the capital would be the difference of the contributed capital and the par value of the stock.
Compute the par value of the stock as displayed below: –
Par Value of the Stock = Number of Shares * Par Value
- Par Value of the Stock = 1,000 x $10
- Par Value of the Stock = $10,000
additional paid-in capital is calculated as:
Additional Paid-In Capital = Contributed Capital – Par Value of the Stock
- Additional Paid-In Capital = $120,000 – $10,000
- Additional Paid-In Capital =$110,000
Hence the business has additional capital of $110, 000 and contributed capital of $120,000 respectively.
Contributed Capital Components
The contributed capital has two broad components namely common stock and additional paid-in capital. The contributed capital therefore can be computed as the sum of common stock and additional paid-in capital. The common stock therefore is defined as the financial instrument that are expressed in terms of value of par corresponding to the number of issued stocks. The additional paid-in capital for the business is defined as money that is given by the share holders which is over and above the par value of the stock.
Contributed Capital on Balance Sheet
The contributed capital can be found in the balance sheet section of the company. It is reported under the stockholders equity of the business. It would generally comprise of the common stock and the additional paid-in capital.
Importance of Contributed Capital
The contributed capital is recorded when the business goes for initial public offering. The paid-in capital is then determined basis the amount of stock that is sold to the investors directly. Therefore, any transactions of trades that happens in the secondary market with respect to the stocks are not recorded as the contributed capital. The contributed capital is important because it shows the excess amount the business gets over and above the par value of the stock.
Contributed Capital vs Common Stock
Common stocks are normally issued at the par value by the business. Each common stock would have a par value which the investors purchase. The value reported under the account for the common stock forms the part of the contributed capital. Therefore, the contributed capital could be the sum of the common stock and the corresponding paid-in capital where the paid-in capital would represent amount of capital that the investors pay to the business that is over and above the par value of the stock.
Advantages of Contributed Capital
Some of the advantages are given below:
- There is no burden on the fixed payment wherein the amount that is received from the investors have no fixed or compulsory obligations of the payment. There are no interest payments that the business has to normally pay when issuing other sources of capital.
- If the business earns good profits, the business then distributes the profits in the form of dividends. In the event if the business is not able to generate suitable profits then the business is liable to make dividend payments to the business.
- The business does not have to pledge any security in the form of collateral which the business has to give if in case it is raising finance through debt. The money raised through contributed capital does not pledges any existing securities and assets which the business may have to do in case the finance is raised through debt.
- If the money raised through contributed capital is used to purchase a tangible asset then the tangible asset could be further used for pledging purpose when the business is looking to raise more finance in the form of debt.
- Since there is a high risk from such investment, the investors expect to earn high rate of return.
Disadvantages of Contributed Capital
Some of the disadvantages are given below:
- For the investors, the contributed capital does not offer much benefits as the profits, growth and dividends from the business depends upon the performance of the business and the returns earned remains to be uncertain.
- The returns earned from the contributed capital are not similar to the returns earned from taking up the debt issues by the business.
- The investors who invest through the contributed capital have the right to select the board of directors as well as they approve critical business decisions. Due to this feature, results in dilution in terms of ownership and control.
- Since the ownership is diluted, there is an appreciation in the oversight level of the management related decisions.
Conclusion
The contributed capital is described in term of the common stock and additional paid-in capital of the business. It describes the amount that the business gathers through the means of issuing stocks to the prospective stockholders and is described in the form of the equity investment as made by the stockholders of the business. The investors procure shares from the business in exchange of cash or liquid assets they own. The business may issue stock and gather finance to pay off the existing debt of the business. With high contributed capital, the business raises the level of equity investment which in turn dilutes the ownership of existing stockholders.
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This is a guide to Contributed Capital. Here we also discuss the introduction and how to calculate contributed capital? along with advantages and disadvantages. You may also have a look at the following articles to learn more –
