Common stock
Shares of stock are given to owners of corporations as evidence of their ownership interests. The ownership of common shares allows common stockholders to vote for the board of directors, receive dividends, and receive assets when the corporations go out of business. The sale of common stock to owners is a source of resources for a corporation. In return for the common shares, the corporation receives resources from the buyer, who becomes an owner.
For example, assume a corporation issues 10,000 shares of common stock and
receives cash of $5 per share on July 1. Show the effects on the company's
resources and sources of resources.
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Total |
= |
Sources of |
+ |
Sources of |
+ |
Sources of |
|
Assets |
= |
Liabilities |
+ |
Stockholders' Equity |
||
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+ $50,000 |
= |
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+ $50,000 |
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The company's resources (assets) increase by $50,000 when it receives cash from owners. This increase in resources is the reason the company issued the stock. The company now has $50,000 more it can use. The company's sources of resources (stockholders' equity) also increase by $50,000 because the owners have a right to the $50,000. If the company went out of business immediately and still had $50,000 after paying all creditors, the owners would receive the $50,000.
As a result of securities regulations designed to
protect investors, the accounting for stock is not quite as straightforward as
in the above illustration. Many corporations assign a par value to all shares
of common stock. In some states, the par value of all common stock issued must
remain in the company until all creditors have been paid. As a result, the
accounting for issuing common stock splits the effects on stockholders' equity
into two parts: (1) the par value of the common stock issued and (2) the excess
of the cash received over the par value of the common stock issued. For
example, if the par value of the 10,000 shares of common stock issued in the
above example had been $2 per share, the effects on the company's resources and
sources of resources would have been as follows.
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Total |
= |
Sources of |
+ |
Sources of |
+ |
Sources of |
|
Assets |
= |
Liabilities |
+ |
Stockholders' Equity |
||
|
+ $50,000 |
= |
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+ $20,000 + $30,000 additional paid-in capital, common stock |
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It is important to note that the company's resources increased by $50,000, the cash received from owners. The increase in stockholders' equity was split into two pieces. The par value of the stock increased the common stock account by $20,000 (10,000 shares x $2 par value per share). Additional paid-in capital, common stock increased by $30,000 ($50,000 total cash received - $20,000 par value of stock issued).
Remembering that assets increase with debits and that debits must equal
credits, prepare the journal entry to record the issuance of the 10,000 shares
of common stock.
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Date |
Description |
Post. |
Debits |
Credits |
|
July 1 |
Cash |
|
50,000 |
|
|
|
Common Stock |
|
|
20,000 |
|
|
Additional Paid-in Capital, Common Stock |
|
|
30,000 |
|
|
10,000 shares of common stock issued |
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|
|
By far the most important point in the above
discussion is that corporations obtain resources when they issue common stock. The
fact that the par value of shares issued is recorded in the common stock
account is a tradition that continues today. For those companies issuing stock
without par values (called no par stock), the full amount received is recorded
as a debit to cash and an equal credit to common stock.
** You now have the background to do text exercises 12.1, 12.2, 12.3, 12.4,
12.5, and 12.6.
Preferred stock
A second major class of stockholders owns preferred stock. Owners of preferred stock have specific rights (or preferences) over those of common stockholders. For example, preferred stockholders have a right to receive dividends before common stockholders. Usually, when a company goes out of business, preferred stockholders also have a right to receive their share of the company's assets before any assets are distributed to common stockholders. In return for preferred shares, the corporation receives resources from the buyer, who becomes an owner.
For example, assume a corporation issues 1,000 shares of $10 par preferred
stock and receives cash of $12 per share on July 1. Show the effects on the
company's resources and sources of resources.
|
Total |
= |
Sources of |
+ |
Sources of |
+ |
Sources of |
|
Assets |
= |
Liabilities |
+ |
Stockholders' Equity |
||
|
+ $12,000 |
= |
|
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+ $10,000 + $2,000 additional paid-in capital, preferred stock |
|
|
The company's resources (assets) increase by $12,000 when it receives cash from owners. This increase in resources is the reason the company issued the stock. The company now has $12,000 more it can use. The company's sources of resources (stockholders' equity) also increase by $12,000 because owners have a right to the $12,000. Similar to the accounting for common stock, the accounting for the issuance of preferred stock splits the effects on stockholders' equity into two parts: (1) the par value of the preferred stock issued and (2) the excess of the cash received over the par value of the preferred stock issued. In the case above, the par value of the preferred stock increased the preferred stock account by $10,000 (1,000 shares x $10 par value per share). Additional paid-in capital, preferred stock increased by $2,000 ($12,000 total cash received - $10,000 par value of stock issued).
Remembering that assets increase with debits and that debits must equal
credits, prepare the journal entry to record the issuance of the 1,000 shares
of preferred stock.
|
Date |
Description |
Post. |
Debits |
Credits |
|
July 1 |
Cash |
|
12,000 |
|
|
|
Preferred Stock |
|
|
10,000 |
|
|
Additional Paid-in Capital, Preferred Stock |
|
|
2,000 |
|
|
1,000 shares of preferred stock issued |
|
|
|
As was the case in the discussion of common stock,
by far the most important point in the preferred stock discussion is that corporations
obtain resources when they issue preferred stock. The fact that the par value
of shares issued is recorded in the preferred stock account is a tradition that
continues today.