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.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $50,000
cash

=

 

 

+ $50,000
common stock

 

 

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.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $50,000
cash

=

 

 

+ $20,000
common stock

+ $30,000 additional paid-in capital, common stock

 

 

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.
 

Date

Description

Post.
Ref.

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

 

 

 

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
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $12,000
cash

=

 

 

+ $10,000
preferred stock

+ $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.
Ref.

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.

 

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