The RayCo corporation's financial structure is depicted by the following equation:
assets = liabilities + owner's equity
$100,000 = $60,000 + $40,000
Let's say the owner contributed $25,000 of owner's equity, through the purchase of common stock, that the common stock has no par value, and that the corporation has not allocated any portion of the $25,000 to capital surplus. Thus, the corporation's minimum or stated capital is $25,000. This also is the total amount of the corporation's contributed capital.
The remaining balance of owner's equity, $15,000, is the corporation's earned surplus or retained earnings. This amount represents the corporation's cumulative earnings, less any distributions of these earnings to the owners (i.e., dividends).
Under the constructive fraud balance sheet test applied in most states, distributions of dividends and for stock redemptions must be limited to the amount of earned surplus. Thus, the corporation can distribute a maximum of $15,000 to the owners on account of their ownership interests.