What is Stock in Accounting? (Part 3)

Example of issuance of Common Stock

Let's assume that a company wants to raise $10,000 through the issuance of common stock. At the time the stock is sold the market price is $50 per share. The company will, therefore, have to issue 200 shares. Let us also assume that the par value of the stock is $10. Here is the journal entry that the company will make following the sale of the shares:

Cash (200 shares x $50)                                           10,000

Common Stock (200 shares x $10))                           2,000

Add’l Paid in Capital (10,000 - 2,000)                       8,000

The journal entry involves the following aspects:

1.      Cash is increased by the number of shares sold multiplied by the market price of the stock to reflect the receipt of the proceeds

2.      Stockholder's equity is increased by $10,000 to reflect the issuance of the stock. This total is divided between the common stock account and the additional paid in capital account. Both of these are stockholder's equity accounts.

3.      The common stock account is increased by the par value multiplied by the number of shares sold. The par value is an arbitrary amount set by the board of directors when the class of stock is authorized by the shareholders for issuance.

4.      The additional paid-in-capital account is increased by the excess of the proceeds from the stock sale less that portion of the proceeds credited to the common stock account.

Common stock can also be authorized as no par. In this case, no par value is assigned to the shares. From an accounting standpoint, the only effect of this designation is that the common stock account is credited for the full amount of the proceeds and no additional paid-in-capital account exists as follows:

Cash (200 shares x $50)                                              10,000

Common Stock (200 shares x $50))                            10,000

A third form for the stock is no par with a stated value. From an accounting standpoint, stated value is treated the same way as par value. For example, assume that the common stock in this example is no par stock with a stated value of $5. The journal entry for the stock issuance would be as follows:

Cash (200 shares x $50)                                              10,000

Common Stock (200 shares x $5))                               1,000

Add’l Paid in Capital (10,000 - 1,000)                         9,000

Stock issuance costs:

When companies issue common stock, the stock is sold through brokers to their retail or institutional clients. These brokers earn a fee for their services and the proceeds received by the company is reduced accordingly. There are two ways in which these stock issuance costs can be accounted for under GAAP.

1.      Treat the issue costs as a reduction of the amounts paid in. The debit to cash and the credit to additional paid-in-capital are reduced accordingly. This method results in a smaller increase in stockholder's equity upon issuance of the shares.

2.      Capitalize the amount as an organizational cost on the balance sheet and amortize the intangible asset similarly to the amortization of goodwill. This method results in a greater increase in stockholder's equity initially and reduced profitability in the future as the amortization expense is recorded.