Stockholders’ Equity Explained: Formula, Components, and Examples

What Is Equity in Accounting?

Equity is the owners’ claim on a company’s assets after all liabilities are subtracted. The formula is Equity = Assets – Liabilities. In a corporation, it’s called stockholders’ equity (or shareholders’ equity) and is made up mainly of contributed capital, such as common stock, preferred stock, and additional paid-in capital, plus retained earnings, minus treasury stock.

Stockholders’ equity is a core topic in Intermediate Accounting and in the FAR (Financial Accounting and Reporting) section of the CPA Exam. Below, you’ll find the formula, each component explained in plain English, a balance sheet example, journal entries, and the mistakes students make most often.

Prefer to learn by watching? Professor Farhat works through an equity calculation in the video section further down this page.

How Do You Calculate Stockholders’ Equity?

There are two ways to calculate stockholders’ equity, and they always give the same answer.

Method 1: Start from the accounting equation. Stockholders’ Equity = Total Assets – Total Liabilities

Method 2: Add up the equity accounts. Stockholders’ Equity = Preferred Stock + Common Stock + Additional Paid-in Capital + Retained Earnings + Accumulated Other Comprehensive Income – Treasury Stock

Accumulated other comprehensive income (AOCI) collects certain unrealized gains and losses that skip the income statement. In consolidated financial statements, noncontrolling interest is also reported within total equity, separately from the parent’s equity.

Quick check using the ABC Corporation balance sheet later in this article:

• Method 1: $300,000 – $160,000 = $140,000
• Method 2: $50,000 + $50,000 + $40,000 + $10,000 – $10,000 = $140,000 (ABC has no AOCI)

Both methods land on $140,000. If your two answers ever disagree on an exam problem, look for a missed account or a treasury stock sign error.

Equity vs. Owner’s Equity vs. Stockholders’ Equity

The idea is the same in every business: equity is what belongs to the owners. Only the name and the accounts change.

Business type	What equity is called	Main accounts
Sole proprietorship	Owner’s equity	Owner’s Capital and Owner’s Drawings (withdrawals)
Partnership	Partners’ equity	A separate capital account for each partner
Corporation	Stockholders’ or shareholders’ equity	Common stock, preferred stock, APIC, retained earnings, AOCI, treasury stock

For a sole proprietor, owner’s equity goes up with owner investments and net income and goes down with withdrawals and net losses. Corporations split equity into contributed capital (what owners paid in) and earned capital (retained earnings). If you’re brand new to these terms, start with What Is Accounting? Definition, Types, and Examples and Elements of Financial Statements.

What Are the Components of Stockholders’ Equity?

Stockholders’ equity is the bottom section of the balance sheet. It shows the owners’ residual interest, meaning what is left for owners after every creditor’s claim is counted. Keep in mind that this is a book value, not a liquidation value. Many assets are recorded at historical cost minus depreciation, so the cash shareholders would actually receive if the company sold everything could be higher or lower than the equity balance.

The Five Core Components

The five components below appear on most corporate balance sheets. Here’s what each one means and how it’s recorded:

1. Common Stock:
   • Nature: Represents equity ownership in a corporation, providing voting rights and entitling holders to a share of the company’s success through dividends and capital appreciation.
   • Valuation: Often recorded at par value, a nominal amount that has little to do with the market value of the shares. Any amount paid over this par value by investors is recorded separately as additional paid-in capital.
2. Preferred Stock:
   • Nature: A class of ownership in a corporation with a higher claim on assets and earnings than common stock, typically with fixed dividends and without voting rights.
   • Valuation: Like common stock, it’s recorded at par value, with any excess received recorded in additional paid-in capital. The terms of preferred stock can significantly affect its accounting treatment, especially regarding dividends and liquidation preferences.

Types of Preferred Stock

Preferred stock is a type of equity security that offers features of both equity and debt, providing a fixed income in the form of dividends but with potentially higher risk than traditional bonds. Preferred stocks are attractive to investors looking for a steady income with priority over common stock in dividend payments and asset liquidation. However, they typically come without the voting rights common stockholders enjoy. There are several types of preferred stock, and each feature changes what the holder is entitled to. For the CPA Exam, focus on cumulative vs. noncumulative, participating vs. nonparticipating, convertible, and callable features. Here are the main types:

1. Cumulative Preferred Stock

• Feature: If dividends are not paid when due, they accumulate and must be paid out before any dividends can be distributed to common stockholders. This feature offers a measure of protection for investors, ensuring they receive missed dividends in the future before common stock dividends are resumed.
• Investor Benefit: Provides a safeguard against missed dividend payments, making it a safer investment during economic downturns or in situations where the company might face short-term financial difficulties.
• Exam Tip: Unpaid cumulative dividends are called dividends in arrears. They are not a liability until the board declares them, so they don’t appear on the balance sheet. Instead, the amount in arrears is disclosed in the notes to the financial statements.

2. Non-Cumulative Preferred Stock

• Feature: Unlike cumulative preferred stock, missed dividend payments are not accumulated. If a company decides not to pay a dividend or is unable to do so, non-cumulative preferred stockholders lose the dividend for that period, with no obligations for the company to pay it later.
• Investor Benefit: Typically, to compensate for the higher risk of potentially missing dividend payments, non-cumulative preferred stocks might offer a higher yield than their cumulative counterparts.

3. Participating Preferred Stock

• Feature: Participating preferred shareholders get their stated dividend first. Then common shareholders get a matching rate on their par value. Anything left over is shared between preferred and common, usually in proportion to their total par values. Fully participating shares have no cap, while partially participating shares stop at a stated maximum rate. Example: a company has 6% fully participating preferred stock with total par of $100,000 and common stock with total par of $300,000, and it declares $40,000 of dividends. Preferred gets $6,000 (6% of $100,000) and common gets $18,000 (6% of $300,000). The remaining $16,000 is split 1/4 to preferred ($4,000) and 3/4 to common ($12,000). Final totals: preferred $10,000 and common $30,000, which is 10% of par for both classes.
• Investor Benefit: Allows investors to share in the company’s profitability beyond the fixed dividend rate, providing an opportunity for higher income if the company performs well.

4. Non-Participating Preferred Stock

• Feature: Holders are entitled only to their fixed dividend rate and do not participate in any additional earnings of the company. This is the standard form for preferred stocks.
• Investor Benefit: Offers predictability and security in dividends, making it suitable for investors looking for steady, fixed-income streams.

5. Convertible Preferred Stock

• Feature: This type allows investors to convert their preferred shares into a predetermined number of common shares, typically after a certain date.
• Investor Benefit: Offers the potential for capital appreciation through conversion if the company’s common stock performs well, providing a balance between income and growth opportunities.

6. Callable Preferred Stock

• Feature: The issuing company has the right to repurchase the stock at a predetermined price after a specified date, allowing the company to retire the stock early.
• Investor Benefit: Often comes with a higher dividend rate to compensate for call risk. The catch is that the company usually calls the shares when interest rates fall, which is exactly when investors would most like to keep that higher dividend.
• Exam Tip: Don’t confuse callable with mandatorily redeemable. If the company is required to buy back the shares on a fixed date, the shares are mandatorily redeemable preferred stock, and FASB ASC 480 classifies them as a liability, not equity.

7. Adjustable-Rate Preferred Stock

• Feature: The dividend rate resets periodically based on a benchmark interest rate, such as SOFR (the Secured Overnight Financing Rate) or Treasury bill rates, so dividends move with market conditions. Older issues often referenced LIBOR, but U.S. dollar LIBOR is no longer published and has been replaced by SOFR.
• Investor Benefit: Helps protect investors against rising interest rates, which makes it attractive when rates are expected to increase.

8. Fixed-Rate Perpetual Preferred Stock

• Feature: Offers a fixed dividend rate with no maturity date, meaning the stock could theoretically continue paying dividends indefinitely.
• Investor Benefit: Provides a predictable, steady stream of income with the stability of a perpetual investment horizon.

Each type of preferred stock serves different investor needs, balancing risk, reward, and investment time horizon. Companies might issue various types of preferred stock to attract a broad range of investors, offering flexibility in financing operations or expansion efforts while providing investors with diverse options to match their investment strategies and risk tolerance.

Retained Earnings, Treasury Stock, and Additional Paid-in Capital

3. Retained Earnings:

• Nature: Cumulative amount of earnings not distributed as dividends to shareholders but retained by the company for reinvestment in business operations, to pay off debt, or to shore up the company’s financial health.
• Calculation: Retained earnings equal all net income the company has earned since it started, minus any net losses, minus all dividends declared (cash, property, and stock dividends). Corrections of errors from earlier years, called prior period adjustments, are recorded directly to retained earnings too. Notice the word declared: retained earnings drop on the day the board declares a dividend, not on the day the cash goes out. A negative balance is called a deficit.

4. Treasury Stock:

• Nature: Shares that were issued and later reacquired by the issuing corporation. They are considered “held in treasury” and not retired.
• Impact: Reduces stockholder equity because it represents money spent to buy back shares. It doesn’t carry voting rights or the right to dividends. Accounting treatments for treasury stock can vary, but the cost method or the par value method are commonly used.

5. Additional Paid-In Capital (APIC):

• Nature: Represents the amount investors paid above the par value of the stock. For example, if a company issues 1,000 shares of $1 par common stock for $9 per share, it records $1,000 in Common Stock and $8,000 in APIC. APIC can also grow from other capital transactions, such as reissuing treasury stock for more than its cost or recognizing stock-based compensation.
• Significance: Together with common and preferred stock, APIC makes up contributed capital, the money owners have put into the business. A large APIC balance is not a sign of investor confidence. Par value is an arbitrary legal amount (often $0.01 or $1 per share), so almost every stock issuance creates APIC.

Want to practice these entries step by step? Start with the free Intermediate Accounting Chapter 1 or the Farhat Lectures Free Sample Course. Preparing for FAR? The courses below go deeper into equity transactions:

Other Possible Components of Stockholders’ Equity

Depending on the company’s structure, operations, and specific financial strategies, additional components might be listed under shareholders’ equity, such as:

6. Accumulated Other Comprehensive Income (AOCI)
   • Represents unrealized gains and losses on certain types of investments and transactions not included in net income, like foreign currency translation adjustments and unrealized gains/losses on certain types of securities.
7. Stock Options
   • When a company grants stock options to employees, it measures the options at their fair value on the grant date and recognizes that cost as compensation expense over the vesting period. Each entry credits an equity account, usually called Additional Paid-in Capital, Stock Options. So the equity balance reflects the compensation cost recognized so far, not the current value of every option granted (FASB ASC 718). Note that in U.S. accounting, ESOP means an employee stock ownership plan, a type of retirement plan, which is a different topic.
8. Convertible Securities
   • Convertible preferred stock is reported in equity. Convertible bonds work differently depending on the framework. Under U.S. GAAP, since FASB’s ASU 2020-06, most convertible bonds are recorded entirely as a liability with no separate equity component, unless the bond is issued at a substantial premium or the conversion feature must be split out as a derivative. Under IFRS (IAS 32), a convertible bond is split into a liability component and an equity component.
9. Warrants
   • Similar to options, warrants provide the holder the right to purchase the company’s stock at a predetermined price before the expiry date.
10. Noncontrolling Interest (Minority Interest)
    • This appears in consolidated statements when a parent controls a subsidiary but owns less than 100% of it. It represents the portion of the subsidiary’s equity owned by outside shareholders. Under FASB ASC 810, it is reported within equity but separately from the parent’s equity.
11. Reserve Accounts
    • Companies reporting under IFRS, or under local rules in many countries, often show reserve accounts in equity, such as a revaluation surplus, capital reserves, and statutory (legal) reserves. U.S. GAAP does not allow property, plant, and equipment to be revalued upward, so you won’t see a revaluation surplus in U.S. financial statements. The closest U.S. GAAP item is appropriated retained earnings, which is rare in practice.
12. Stock Dividends Distributable
    • When a company declares a stock dividend but has not yet issued the shares, the par value of those shares sits in an equity account called Common Stock Dividend Distributable. It is equity, not a liability, because the company will hand out shares, not cash. Cash dividends that have been declared but not yet paid are different: they are always a current liability (Dividends Payable) under both U.S. GAAP and IFRS.
13. Stock Dividends
    • A stock dividend is not a separate line on the balance sheet. It moves an amount from retained earnings into common stock and APIC, so total equity does not change. A small stock dividend (less than about 20% to 25% of outstanding shares) is recorded at the shares’ fair value. A large stock dividend (more than about 20% to 25%) is recorded at par value.

The specific composition and naming of equity components can vary significantly across companies and jurisdictions, reflecting differences in corporate structure, accounting standards (such as U.S. GAAP vs. IFRS), and the nature of the business operations. Understanding these components is essential for analyzing a company’s financial health and the value attributable to shareholders.

What Each Equity Component Tells You

Each component of stockholder equity offers insights into different aspects of a company’s financial and operational health. For instance, a large retained earnings balance indicates a company with a strong profit-generating engine or a conservative dividend policy. A high level of treasury stock might suggest a company that has been actively buying back its shares, which can be a sign of self-confidence from management but also reduces equity. APIC shows how much owners have contributed above par value. Because par value is arbitrary, the size of APIC tells you about the company’s financing history, not about investor confidence.

Together, these components form a comprehensive picture of stockholder equity, reflecting both the historical decisions made by the company (like dividend policies and share buybacks) and the market’s valuation and expectations for the company. Understanding these components is crucial for anyone looking to gauge a company’s financial standing, potential for future growth, and overall strategy from an equity perspective.

Video: How to Calculate Stockholders’ Equity (CPA FAR)

In this segment from Farhat Lectures, Professor Farhat demonstrates how common stock, paid-in capital, retained earnings, and treasury stock combine to determine total stockholders’ equity. The worked example also shows how net income, dividends, and treasury stock transactions affect the ending balance. Watch the segment before reviewing the balance-sheet example below.

Selected segment: 7:52–12:03. Watch the full Stockholders Equity lecture on the Farhat Lectures YouTube channel.

Full lecture timeline:

• 0:00 Introduction
• 2:14 Common shareholder rights
• 3:32 Par value concept
• 4:35 Journalizing stock issuance and APIC as a plug
• 7:52 Equity statement calculations (net income, dividends, treasury stock)
• 12:03 Preemptive rights

Stockholders’ Equity Example: ABC Corporation Balance Sheet

Here’s a simplified example of how stockholders’ equity might be presented in a corporation’s balance sheet:

ABC Corporation

Balance Sheet

As of December 31, 2024

Assets	Amount
Cash and Cash Equivalents	$50,000
Accounts Receivable	$30,000
Inventory	$40,000
Property, Plant, and Equipment (net)	$180,000
Total Assets	$300,000

Liabilities	Amount
Accounts Payable	$30,000
Short-term Debt	$30,000
Long-term Debt	$100,000
Total Liabilities	$160,000

Stockholders’ Equity	Amount
Common Stock ($1 par, 50,000 shares issued, 49,000 outstanding)	$50,000
Preferred Stock (6%, $10 par, 5,000 shares issued and outstanding)	$50,000
Additional Paid-in Capital	$40,000
Retained Earnings	$10,000
Treasury Stock (at cost, 1,000 shares)	($10,000)
Total Stockholders’ Equity	$140,000

| Total Liabilities and Stockholders’ Equity | $300,000 |

Notice that the accounting equation balances: total assets of $300,000 equal total liabilities of $160,000 plus total stockholders’ equity of $140,000. Also notice that ABC has issued 50,000 common shares but only 49,000 are outstanding, because it holds 1,000 shares as treasury stock. Treasury shares don’t vote, don’t receive dividends, and are left out of per-share calculations.

How ABC’s Equity Changes During the Year (Roll-Forward Example)

Now let’s move ABC Corporation forward through 2025. During the year:

1. ABC earns net income of $25,000.
2. The board declares cash dividends of $8,000: $3,000 to preferred shareholders (5,000 shares × $10 par × 6%) and $5,000 to common shareholders. ABC pays them before year-end.
3. ABC reissues 400 treasury shares for $14 per share. It originally bought them for $10 per share.

Journal entries

Transaction	Account	Debit	Credit
1. Close net income	Income Summary	$25,000
	Retained Earnings		$25,000
2a. Declare dividends	Retained Earnings	$8,000
	Dividends Payable		$8,000
2b. Pay dividends	Dividends Payable	$8,000
	Cash		$8,000
3. Reissue treasury stock	Cash (400 × $14)	$5,600
	Treasury Stock (400 × $10)		$4,000
	Paid-in Capital from Treasury Stock		$1,600

Stockholders’ equity at December 31, 2025

Stockholders’ Equity	Amount
Preferred Stock (6%, $10 par, 5,000 shares issued and outstanding)	$50,000
Common Stock ($1 par, 50,000 shares issued, 49,400 outstanding)	$50,000
Additional Paid-in Capital	$40,000
Paid-in Capital from Treasury Stock	$1,600
Retained Earnings ($10,000 + $25,000 – $8,000)	$27,000
Treasury Stock (at cost, 600 shares)	($6,000)
Total Stockholders’ Equity	$162,600

Check: $140,000 beginning equity + $25,000 net income – $8,000 dividends + $5,600 cash from reissuing treasury stock = $162,600.

Two things to notice. Paying the dividend (entry 2b) did not reduce equity again, because retained earnings already dropped when the dividend was declared. And the $1,600 extra received on the treasury shares went to paid-in capital, not to the income statement. This year-end roll-forward is the same logic behind the statement of changes in stockholders’ equity.

Two Quick Ratios Using Equity

Using ABC’s December 31, 2024 balance sheet:

• Debt-to-equity ratio = Total Liabilities ÷ Total Stockholders’ Equity = $160,000 ÷ $140,000 = 1.14. ABC has $1.14 of liabilities for every $1 of equity.
• Book value per common share = (Total Stockholders’ Equity – Preferred Equity) ÷ Common Shares Outstanding = ($140,000 – $50,000) ÷ 49,000 = $1.84. This assumes the preferred stock has no dividends in arrears and a liquidation value equal to its par value.

Notice that book value per share uses shares outstanding (49,000), not shares issued (50,000), because treasury shares are excluded.

Common Stockholders’ Equity Mistakes on the CPA Exam

These are the traps that cost students points most often:

1. Treating treasury stock as an asset. Treasury stock is a contra-equity account. It reduces total equity and never appears on the asset side.
2. Reducing retained earnings when dividends are paid. Retained earnings drop on the declaration date. The payment date only clears Dividends Payable.
3. Recording a gain or loss on treasury stock. Under the cost method, reissuing treasury shares above cost credits Paid-in Capital from Treasury Stock. Reissuing below cost debits that account first, then retained earnings. Nothing goes to the income statement.
4. Making a journal entry for a stock split. A split only changes the number of shares and the par value per share. Total equity, and every equity account balance, stays the same.
5. Recording dividends in arrears as a liability. Unpaid cumulative preferred dividends are disclosed in the notes until the board declares them.
6. Using par value for a small stock dividend. Small stock dividends (under about 20% to 25%) are recorded at fair value. Only large stock dividends use par value.

Key Takeaways

• Equity = Assets – Liabilities. It’s the owners’ residual claim on the company.
• Stockholders’ equity = contributed capital (preferred stock, common stock, APIC) + retained earnings + AOCI – treasury stock.
• Retained earnings fall when dividends are declared, not when they’re paid.
• Treasury stock is contra-equity. Reissuing it never creates income statement gains or losses.
• Equity is a book value, so it rarely matches a company’s market value.

Frequently Asked Questions About Equity

Is equity the same as book value or net worth?

Yes. In accounting, equity is a company’s book value, also called net assets: total assets minus total liabilities. It is not the same as market value. Market value (market capitalization) is the share price times the number of shares outstanding, and it usually differs a lot from book value.

Can stockholders’ equity be negative?

Yes. When total liabilities are larger than total assets, equity is negative, which is often called a stockholders’ deficit. It usually happens after years of losses create a deficit in retained earnings, or after large share buybacks or dividends funded with debt.

Do dividends reduce stockholders’ equity?

Cash and property dividends reduce retained earnings, and therefore total equity, on the declaration date. Paying the dividend later only settles the liability and does not reduce equity a second time. Stock dividends don’t change total equity at all; they just move amounts from retained earnings to paid-in capital.

What’s the difference between a stock dividend and a stock split?

Both increase the number of shares, but only a stock dividend needs a journal entry. Suppose a company has 100,000 shares of $1 par common stock outstanding. A 10% stock dividend when the market price is $20 creates 10,000 new shares recorded at fair value: debit Retained Earnings $200,000, credit Common Stock Dividend Distributable $10,000, and credit Additional Paid-in Capital $190,000. When the shares are issued, debit Common Stock Dividend Distributable and credit Common Stock for $10,000. A 2-for-1 stock split needs no journal entry: shares double to 200,000 and par value drops to $0.50. Total equity stays the same in both cases.

How is stockholders’ equity tested on the CPA Exam?

Equity falls under Area II, Select Balance Sheet Accounts, of the FAR section, which carries 30% to 40% of the FAR score under the AICPA’s 2026 CPA Exam Blueprints. Expect tasks such as preparing journal entries for stock issuances, stock dividends, stock splits, and treasury stock. Area I also asks you to prepare and correct a statement of changes in equity.

Ready to test yourself? Work through equity questions in the FAR Test Bank, or try the Free Sample Course to see how Professor Farhat teaches before you commit.

About the Author

Mansour Farhat, CPA, CIA, DBA, is the founder of Farhat Lectures and its YouTube channel. He holds a Doctor of Business Administration from Temple University and a Master of Accountancy from Bloomsburg University, and he teaches accounting students and CPA, CMA, and EA candidates. Read more about Professor Farhat.