Difference between Common Shares and Retained Earnings

Question

So I'm looking at my accounting textbook and it states that the total common shares account indicate 100% ownership in the company. Yet there are other shareholder's equity accounts such as Retained Earnings which are not under "Common Shares". I'm wondering how it represents 100% ownership if these other accounts exist (Retained Earnings being an accumulation of net income). Also how would you know what portion Preferred Shareholders own of a company?

Answer 1

Retained Earnings is the total of all previous profits and losses. It's basically the equity that has been "earned" throughout the life of the business (as opposed to raised through debt or stock offerings).

Common Shares is the amount of equity that has been sold in the open market through stock. Sometimes you'll see Common Shares split into a smaller number representing the stock's "par" value (which is another discussion) and "Paid-In Capital", which represents the amount that the market initially paid for the stock above it's "par" value.

So the shareholders "own" 100% of the equity of the company, which includes retained earnings.

Also how would you know what portion Preferred Shareholders own of a company?

Preferred Shares are an alternate way for a company to raise money. It's not completely equity in the sense that its value comes from a contractually obligated dividend payment, not its ownership percentage (it's typically a very small percentage of overall equity rights), but it's not completely debt in the sense that is it comes after debt (but before common shares) in the order of payback in the event of a liquidation.

To determine how much is owned by preferred shareholders, look to see if the preferred shares can be converted to common shares (which would only happen if the value of the common shares is worth more than the preferred dividends). Then divide that amount by the total number of equity shares (common + converted preferred).

So if a company has 9,000 common shares and 100 preferred shares, each of which is convertible to 10 common shares, then the total number of potential shares is 10,000 (9,000 common + 1,000 converted preferred), of which 90% is held by common shareholders and 10% is held be preferred shareholders.

Answer 2

1. Retained Earnings being lumped with common stock is nothing more than an accounting fiction to balance the books. (The extra cash in the bank needs to be balanced by Something, and RE is what that Something is.)
2. Preferred Stock shares "just" grant their owners first dibs on dividends. They don't get to vote for board members.