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.

What is Stock in Accounting? (Part 2)

What is Common Stock and Preferred Stock?

Common Stock

The holders of common stock can reap two main benefits: capital appreciation and dividends. Capital appreciation occurs when a stock's value increases over the amount initially paid for it. The stockholder makes a profit by selling the stock at its current market value after capital appreciation.

Dividends, which are taxable payments, are paid to a company's shareholders from retained or current earnings. Typically, dividends are paid to stockholders on a quarterly basis. Payments are usually made in the form of cash, but other property or stock can also be used. Payment of dividends, however, hinges on a company's capacity to grow -- or maintain -- current or retained earnings. This means ongoing payment of dividends cannot be guaranteed.

Common stock has the additional benefit of enabling its holders to vote on company issues and when choosing the company's leadership. Usually, one share of common stock equals one vote.

Preferred Stock

Preferred stock doesn't offer the same profit potential as common stock, but it’s a more stable investment vehicle because it guarantees a regular dividend that isn't directly tied to the market as with the price of common stock. Preferred stock guarantees dividends, which common stock does not. The price of preferred stock is tied to interest rate levels; it tends to decrease if interest rates go up and increase if interest rates fall.

Preferred stockholders get priority when it comes to the payment of dividends. If a company is liquidated, preferred stockholders get paid before those who own common stock. In addition, if a company goes bankrupt, preferred stockholders enjoy priority distribution of the company's assets; holders of common stock don't receive any corporate assets until preferred stockholders have been compensated.

Like common stock, preferred stock represents ownership in a company. However, owners of preferred stock do not get voting rights in the business.

The difference between Common Stock and Preferred Stock

Common Stock	Preferred Stock
The capital stock (or simply stock) of a business entity represents the original capital paid into or invested in the business by its founders. It's a security for creditors since it cannot be withdrawn to the detriment of the creditors.	Preferred stock, also called preferred shares, preference shares, or simply preferred, is a special equity security that has properties of both equity and a debt instrument and is generally considered a hybrid instrument.

 

What is Stock in Accounting? (Part 1)

Common stock is a form of corporate equity ownership, a type of security. The word “common stock” widely being used in the United Stated, which the rest parts of world, is using the word “voting share” or “ordinary share”.

Other than common stock, there is another type of stock, which is called as preferred stock. If both types of stock exist, common stock holders cannot be paid dividends until all preferred stock dividends (including payments in arrears) are paid in full.

In the event of bankruptcy, common stock investors receive any remaining funds after bondholders, creditors (including employees), and preferred stock holders are paid. As such, common stock investors often receive nothing after a bankruptcy.

On the other hand, common shares on average perform better than preferred shares or bonds over time. Common stock usually carries with it the right to vote on certain matters, such as electing the board of directors. However, a company can have both a "voting" and "non-voting" class of common stock.

Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering. There is no fixed dividend paid out to common stock holders and so their returns are uncertain, contingent on earnings, company reinvestment and efficiency of the market to value and sell stock.

Additional benefits from common stock include earning dividends and capital appreciation.