Question

Why is the distinction between paid-in capital and retained earnings important?

Short answer

Paid in capital reflects investments made by equity holders, while retained earnings reflect the balance of profits in the business.

Step-by-step solution

Definition of Retained Earnings

An organization's retained earnings are the profits left over after they have deducted their direct expenses, indirect expenses, income taxes, and dividends to shareholders.

Distinction between Paid-In Capital and Retained Earnings

The legal right to declare dividends out of retained earnings is available in all states, but out of paid-in capital is not allowed in many states. A corporation's continued existence and growth are determined by its earnings, which are viewed by management, shareholders, and others. In comparison, paid-in capital shows the value of the investment made by the investor in the company. Retained earnings are determined to measure the profit remains for the year; on the other hand, paid-up capital is used to measure a company's capital valuation.