Most companies have limited sources of finance. Usually, these include equity and debt. Of these, the former comes from a company’s shareholders. In exchange for these instruments, the company issues shares, which provide the holder with several rights. These rights include receiving dividends and voting rights. The latter source of finance comes from third parties, such as banks and other financial institutions.
For most companies, issuing stock is one of the most accessible sources of finance. Usually, the most common type of this source includes common stock, also known as ordinary stock. Some companies may also have other options when raising finance from this source. Usually, this involves preferred stock, which differs from common stock.
For companies, common stock represents its ownership. However, other sources of finance or equity do not have the same effect. On top of that, the accounting for the issuance of common stock differs from other sources. This accounting treatment also differentiates this finance source on the balance sheet. Before understanding the accounting for the allotment of common stock, it is crucial to know what it is.
What is Common Stock?
Common stock is a financial instrument that represents the ownership of a company. In accounting, this term describes the total finance received from a company’s shareholders over the years. Companies may also refer to it as ordinary stock, which represents the same concept. In most circumstances, common stock is the only type of equity instrument that companies may issue.
Common stock comes with several features, such as the right to receive dividends and vote in the company’s matters. The former involves the distribution of profits among shareholders. In most cases, companies choose to do so regularly. However, companies may also decide not to pay dividends. Therefore, the common stock does not come with guaranteed distributions. Instead, they promise this distribution if the company chooses to do so.
The second feature that differentiates common stock from others is voting rights. These voting rights allow the shareholders to dictate how the company operates. For example, they can elect the board of directors and vote on a company’s policies. However, the same rights are not a part of the other types of stock that companies offer, for instance, preferred stock.
The common stock also comes with the right to receive a part of the underlying company’s assets if it liquidates. However, this feature is similar to dividends. Shareholders can only get access to those assets if the residual resources exceed the company’s liabilities. On top of that, preferred shareholders will get a preference during the distribution of the remaining assets. Therefore, shareholders don’t get guaranteed assets.
Overall, common stock is a security that represents a company’s ownership. For the underlying company, it provides a source of finance. It also establishes the relationship between the company and its owners or shareholders. On top of that, the common stock also represents the overall finance received from shareholders in accounting. In the balance sheet, this finance falls under the shareholders’ equity section.
What is the Accounting for Issuance of Common Stock?
The accounting for the issuance of a common stock involves several steps. However, it is crucial to understand that every share has a par value. This par value represents the share’s value in the company’s articles. When a company gets incorporated, it must decide this par value. However, this value does not represent the finance that the company receives for underlying shares. In some circumstances, they may get more or less.
In accounting, the finance received from the issuance of a common stock goes into two accounts. These include the share capital and share premium accounts. For some companies, the terms may differ, for example, paid-in capital and additional paid-in capital. In essence, however, the accounting treatment for the issuance of common stock will remain the same.
The differentiation between the two accounts depends on the share’s par value. Accounting standards require companies to recognize the finance received from issuing shares in the two accounts. However, the share capital account only holds the par value for the issued shares. Furthermore, this account doesn’t necessarily include the finance received from the issuance of shares. It only involves the par value of any shares issued.
Any finance received in excess of the share’s par value ends up on the share premium account. This account includes any compensation received over that value. If companies issue shares at below the par value, this account will also get impacted. However, those instances are rare. In most cases, the share premium account involves recording excess funds received from new share issues.
Overall, accounting for the issuance of a common stock involves the separation of the compensation received. As mentioned, this process includes calculating the par value of the underlying shares issued. This amount goes into the share capital account. Any excess amount received ends up on the share premium account. Therefore, it is crucial to identify the par value.
What are the journal entries for the Issuance of Common Stock?
The journal entries for the issuance of common stock impact three accounts. The first involves the debit side, which usually includes the account to record the compensation. In most cases, companies receive payments through the bank for this process. However, companies may also issue shares in other cases, for example, in exchange for goods or services.
The second account includes the share capital account. As mentioned, this account will only hold the par value for the shares issued by the company. For companies, the process of separating the amount is crucial in determining the amount for this account. Even when companies don’t receive compensation, they must credit the par value to this account.
However, the accounting for the issuance of common stock doesn’t involve two entries, like most other transactions. It also impacts another financial account, which is the share premium account. As mentioned, this account records any exchange amount received above the par value. The amount in this account will include the difference between the funds received and the par value.
Overall, the journal entries for the issuance of common stock will be as follows.
In the above journal entries, the debit side involves the bank account. However, some companies may also issue shares in exchange for other instruments, for example, convertibles or warrants. Similarly, some companies may offer stock to pay suppliers for their products or services. In those cases, the debit side will change. Nonetheless, the credit side will remain the same in most share issues.
A company, ABC Co., issues 1,000 common stock to investors. The company charges $150 per share for this issuance, making the overall finance received $150,000. However, the par value of those shares is $100, making the total par value of those shares $100,000. ABC Co. receives the finance through a bank account. Therefore, the journal entries for this process will be as follows.
As mentioned, the share capital account will only include the par value of the shares. The excess amount of $50,000 ($150,000 – $100,000) ended up on the share premium account. The debit side will include the full amount of the finance received.
Common stock represents a company’s shares that provide various features. These features include the right to receive dividends and voting rights. Usually, the accounting for the issuance of a common stock involves three accounts. These include compensation, share capital and share premium accounts. For that, it is crucial to separate the par value of shares from the total finance received.