Ownership in a corporation is represented by stock certificates, which is why the owners are called stockholders. In some states, stockholders are called shareholders. Ownership interest in a corporation is made up of common, and optionally, preferred stocks [shares]. The common shares represent the residual risk-taking ownership of the corporation after the satisfaction of all claims of creditors and senior classes of equity. A corporation may issues stocks for cash or in exchange with assets or services.
Occasionally, a corporation may buy back stocks that have been bought by stockholders. This type of stock called “treasury stock”.
This post shows you how to account simple stock transactions, including treasury stocks. Follow on…
The accounting for the sale of stocks by a corporation depends upon whether the stock has a par or stated value. If there is a par or stated value, the amount of the proceeds representing the aggregate par or stated value is credited to the common or preferred stock account. The aggregate par or stated value is generally defined as legal capital not subject to distribution to shareholders. Proceeds in excess of par or stated value are credited to an additional paid-in capital account. The additional paid-in capital represents the amount in excess of the legal capital that may, under certain defined conditions, be distributed to shareholders.
Stock Issued For Cash
Corporations may issue stock for cash.
Common stock Issued for Cash
Lie Dharma Putra Corporation issues 5,000 shares of its $1 par value common stock at par for cash, that means the company will receive $5,000 (5,000 shares × $1 per share). The sale of the stock is recorded by increasing (debiting) cash and increasing (crediting) common stock by $5,000.
[Debit]. Cash = $5,000
[Credit]. Common Stock = $5,000
(To record sale of stock)
If the Lie Dharma Putra Corporation sold their $1 par value stock for $5 per share, they would receive $25,000 (5,000 shares × $5 per share) and would record the difference between the $5,000 par value of the stock (5,000 shares × $1 par value per share) and the cash received as additional paid-in-capital in excess of par value (often called additional paid-in-capital).
[Debit]. Cash = $25,000
[Credit]. Common Stock (5,000 × $1) = $5,000
[Credit]. Additional Paid-in-Capital = $20,000
(To record sale of 5,000 shares of stock at $5 per share)
Notes: When no-par value stock is issued and the Board of Directors establishes a stated value for legal purposes, the stated value is treated like the par value when recording the stock transaction. If the Board of Directors has not specified a stated value, the entire amount received when the shares are sold is recorded in the common stock account. If a corporation has both par value and no-par value common stock, separate common stock accounts must be maintained.
Preferred Stock Issued for Cash
The sale of preferred stock is accounted for using these same principles. A separate set of accounts should be used for the par value of preferred stock and any additional paid-in-capital in excess of par value for preferred stock. Preferred stock may have a call price, which is the amount the “issuing” company could pay to buy back the preferred stock at a specified future date.
If Lie Dharma Putra Corporation issued 1,000 shares of its $1 par value preferred stock for $100 per share, the entry to record the sale would increase (debit) cash by $100,000 (1,000 shares × $100 per share), increase (credit) preferred stock by the par value, or $1,000 (1,000 shares × $1 par value), and increase (credit) additional paid-in-capital—preferred stock for the difference of $99,000.
[Debit]. Cash = $100,000
[Credit]. Preferred Stock (1,000 × $1) = $1,000
[Credit]. Additional Paid-in-Capital (Preferred Stock) = $99,000
(To record sale of 1,000 shares of preferred stock at $100 per share)
Stock Issued In Exchange For Assets Or Services
If corporations issue stock in exchange for assets or as payment for services rendered, a value must be assigned using the cost principle. The cost of an asset received in exchange for a corporation’s stock is the market value of the stock issued. If the stock’s market value is not yet determined (as would occur when a company is just starting), the fair market value of the assets or services received is used to value the transaction. If the total value exceeds the par or stated value of the stock issued, the value in excess of the par or stated value is added to the additional paid-in-capital (or paid-in-capital in excess of par) account.
For example, the Lie Dharma Putra Corp, a start-up company, issues 10,000 shares of its $0.50 par value common stock to its attorney in payment of a $50,000 invoice from the attorney for costs incurred by the law firm to help establish the corporation. The entry to record this exchange would be based on the invoice value because the market value for the corporation’s stock has not yet been determined. The entry to record the transaction increases (debits) organization costs for $50,000, increases (credits) common stock for $5,000 (10,000 shares × $0.50 par value), and increases (credits) additional paid-in-capital for $45,000 (the difference). Organization costs is an intangible asset, included on the balance sheet and amortized over some period not to exceed 40 years.
[Debit]. Organization Costs = $50,000
[Credit]. Common Stock (10,000 × $0.50) = 5,000
[Credit]. Additional Paid-in-Capital = $45,000
(To issue 10,000 shares to settle attorney’s invoice for startup costs)
If the Lie Dharma Putra Corp, an established corporation, issues 10,000 shares of its $1 par value common stock in exchange for land to be used as a plant site, the market value of the stock on the date it is issued is used to value the transaction. The fair market value of the land cannot be objectively determined as it relies on an individual’s opinion and therefore, the more objective stock price is used in valuing the land.
The stock transactions discussed here all relate to the initial sale or issuance of stock by Lie Dharma Putra Corp. Subsequent transactions between stockholders are not accounted for by Lie Dharma Putra. and have no effect on the value of stockholder’s equity on the balance sheet. Stockholder’s equity is affected only if the corporation issues additional stock or buys back its own stock.
Treasury stock is the corporation’s issued stock that has been bought back from the stockholders. As a corporation cannot be its own shareholder, any shares purchased by the corporation are not considered assets of the corporation.
Assuming the corporation plans to re-issue the shares in the future, the shares are held in treasury and reported as a reduction in stockholder’s equity in the balance sheet. Shares of treasury stock do not have the right to vote, receive dividends, or receive a liquidation value.
Companies purchase treasury stock if shares are needed for employee compensation plans or to acquire another company, and to reduce the number of outstanding shares because the stock is considered a good buy. Purchasing treasury stock may stimulate trading, and without changing net income, will increase earnings per share.
The cost method of accounting for treasury stock records the amount paid to repurchase stock as an increase (debit) to treasury stock and a decrease (credit) to cash. The treasury stock account is a contra account to the other stockholders’ equity accounts and therefore, has a debit balance. No distinction is made between the par or stated value of the stock and the premium paid by the company. To illustrate, assume Lie Dharma Putra Corporation repurchases 15,000 shares of its $1 par value common stock for $25 per share. To record this transaction, treasury stock is increased (debited) by $375,000 (15,000 shares × $25 per share) and cash is decreased (credited) by a corresponding amount. The entry looks like the following:
[Debit]. Treasury Stock = $375,000
[Credit]. Cash = $375,000
(To repurchase 15,000 shares at $25)
In the balance sheet, treasury stock is reported as a contra account after retained earnings in the stockholder’s equity section. This means the amount reported as treasury stock is subtracted from the other stockholders’ equity amounts. Treasury shares are included in the number reported for shares issued but are subtracted from issued shares to determine the number of outstanding shares.
When treasury stock is sold, the accounts used to record the sale depend on whether the treasury stock was sold above or below the cost paid to purchase it. If the treasury stock is sold above its cost, the sale increases (debits) cash for the proceeds received, decreases (credits) treasury stock for the cost paid when the treasury stock was repurchased, and increases (credits) additional paid-in-capital—treasury stock for the difference between the selling price and the repurchase price. If Lie Dharma Putra Corporation subsequently sells 7,500 of the shares repurchased for $25 for $28, the entry to record the sale would be as shown:
[Debit]. Cash (7,500 × $28) = $210,000
[Credit]. Treasury Stock (7,500 × $25) = $187,500
[Credit]. Additional paid-in-capital (treasury stock) = $22,500
(To record sale of 7,500 shares of treasury stock at $28)
When the remaining 7,500 shares are sold, the entry to record the sale includes an increase (debit) to cash for the proceeds received, a decrease (credit) to treasury stock for the repurchase price of $25 per share or $187,500, and a decrease (debit) to additional paid-in-capital treasury stock, if the account has a balance, for the difference.
If the difference between cash received and the cost of the treasury stock is greater than the additional paid-in-capital—treasury stock account, retained earnings is reduced (debited) for the remaining amount after the additional paid-in-capita—treasury stock account balance is reduced to zero. If Lie Dharma Putra Corporation sells the remaining 7,500 shares of its treasury stock for $21, the entry to record the sale would be as shown:
[Debit]. Cash (7,500 × $21) = $157,500
[Debit]. Additional paid-incapital (treasury stock) = $22,500
[Debit]. Retained Earnings = $7,500
[Credit]. Treasury Stock (7,500 × $25) = $187,500
(To record sale of 7,500 shares of treasury stock at $21)
If the Board of Directors decides to retire the treasury stock at the time it is repurchased, it is cancelled and no longer considered issued. When this occurs, the common stock and additional paid-in-capital accounts are decreased (debited) for the amounts recorded in these accounts when the stock was originally issued and cash is decreased (credited) for the amount paid to repurchase the stock.
If the repurchase price is more than the original issue price, the difference is a decrease (debit) to the additional paid-in-capital—treasury stock account until its balance reaches zero. Once the balance in the additional paid-in-capital—treasury stock account reaches zero, or if there is no such account, the difference is a decrease (debit) to retained earnings.
If the repurchase price is less than the original selling price, the difference increases (is credited to) the additional paid-in-capital account.
Here are some essential stock terminology may be helpful to understand.
Common stock – The class of stock issued most frequently by a corporation. Common stock ownership normally includes the rights to vote on stockholder matters, to receive dividends only after preferred stockholders, and, in the event of a liquidation, to receive their investment back if anything remained after the creditors were paid and the investment of the preferred stockholders was returned to them. It may have a par value or be no-par value stock that may or may not have a stated value.
Preferred stock – Preferred stock is a class of stock that normally has the right to receive dividends, and in the case of liquidation of the corporation, a return of investment before the common stockholders. Preferred stock usually does not include a voting right.
Dividends – A dividend is a distribution by a corporation to its owners in the form of cash, assets, or the company’s stock. Stockholders do not have withdrawal accounts like sole proprietors or partners because the only way they can get money from the corporation is if the Board of Directors authorizes a dividend.
Stockholder’s equity – In a corporation’s balance sheet, the owners’ equity section is called stockholders’ equity. It includes the contributed capital accounts and retained earnings.
Retained earnings – The amount of net income a corporation has earned since it began in business that has not been distributed as dividends to its stockholders. Net income increases retained earnings. Dividends, net losses, and some treasury stock transactions decrease retained earnings. Net income, and dividends, if they are recorded in a separate account, are transferred to retained earnings during the closing entry process.
Authorized stock – Per the articles of incorporation, the type and number of shares of stock a corporation may sell. Approval by stockholders is required to issue any sharesabove the authorized level.
Issued stock – The number of shares transferred to stockholders in exchange for cash, assets, or services rendered.
Outstanding stock – Issued stock that is held by stockholders and has not been bought back by the corporation.
Treasury stock – Issued stock that has been bought back by the corporation.
Market value – The price set by interested buyers and sellers for the stock of publicly traded companies.
Par value – The value assigned in a corporation’s articles of incorporation to one share of stock. It appears on the stock certificate. In some states, the par value of all outstanding shares is considered the legal capital of a corporation. Legal capital is the amount of contributed capital that must remain in the corporation and may not be paid out in dividends.
Contributed capital – Also called paid-in capital, it is the amount of value received by the corporation when it issues its stock. It includes the par value and any amount received in excess of the par value.
No-par value stock – Shares of stock that do not include a par value. The Board of Directors may assign a value to this type of stock.
Stated value – The value assigned to no-par value stock by the Board of Directors of a corporation.