Stock is an ownership share in an entity, representing a claim against its assets and profits. The owner of stock is entitled to a proportionate share of any dividends declared by an entity's board of directors, as well as to any residual assets if the entity is liquidated or sold. If there are no residual assets in the event of a liquidation or sale, then the stock is worthless. Depending upon the type of stock issued, the holder of stock may be entitled to vote on certain entity decisions.
Types of Stock Transactions
There are three main types of stock transactions, which are:
- The sale of stock for cash
- Stock issued in exchange for non-cash assets or services
- The repurchase of stock
We will address the accounting for each of these stock transactions below.
The Sale of Stock for Cash
The structure of your journal entry for the cash sale of stock depends upon the existence and size of any par value. Par value is the legal capital per share, and is printed on the face of the stock certificate.
If you are selling common stock, which is the most frequent scenario, then you record a credit into the Common Stock account for the amount of the par value of each share sold, and an additional credit for any additional amounts paid by investors in the Additional Paid-In Capital account. You record the amount of cash received as a debit to the Cash account.
For example, Arlington Motors sells 10,000 shares of its common stock for $8 per share. The stock has a par value of $0.01. Arlington records the share issuance with the following entry:
|Common Stock ($0.01 par value)||100|
|Additional paid-in capital||79,900|
If Arlington were to only sell the stock for amount equal to the par value, then the entire credit would be to the Common Stock account. There would be no entry to the Additional Paid-In Capital account.
If a company were selling preferred stock instead of common stock, the entry would be the same, except that the accounts in which the entries are made would be identified as preferred stock accounts, not common stock.
Stock Issued in Exchange for Non-Cash Assets or Services
If a company issues stock in exchange for non-cash assets or services received, then it uses the following decision process to assign a value to the shares:
- First, determine the market value of the shares, if there is a trading market for them;
- If there is no trading market for the shares, then instead assign a value to the shares based on the fair market value of the non-cash assets received or services received.
After determining the value of the shares using one of the two methods just noted, the journal entry is the same as was just described, except that a different account is debited, rather than the Cash account.
For example, Arlington Motors goes public, and its stock trades at $9 per share. It issues 5,000 shares to its product design firm for services rendered. The stock has a par value of $0.01. Arlington records the share issuance with the following entry:
|Outside services expense||45,000|
|Common Stock ($0.01 par value)||50|
|Additional paid-in capital||44,950|
The Repurchase of Stock (Treasury Stock)
The most common treasury stock accounting method is the cost method. Under this approach, the cost at which shares are bought back is listed in a treasury stock account, which is reported in the stockholders' equity section of the balance sheet as a deduction (this is a contra equity account). When the shares are subsequently sold again, any sale amounts exceeding the repurchase cost are credited to the additional paid-in capital account, while any shortfalls are first charged to any remaining additional paid-in capital remaining from previous treasury stock transactions, and then to retained earnings if there is no additional paid-in capital of this type remaining.
The Board of Directors of Arlington Motors chooses to buy back 1,000 of its common shares at $10 per share. The entry is:
If management later decides to permanently retire treasury stock that was originally recorded under the cost method, then it backs out the original par value and additional paid-in capital associated with the initial stock sale, and charges any remaining difference to the retained earnings account.
To continue with the previous example, if the 1,000 shares had a par value of $0.01 each, had originally been sold for $8,000 and all were to be retired, the entry would be as follows:
|Additional paid-in capital||7,990|
If instead Arlington subsequently chooses to sell the shares back to investors at a price of $12 per share, the transaction is:
|Additional paid-in capital||2,000|
If treasury stock is subsequently sold for more than it was originally purchased, the excess amount may also be recorded in an additional paid-in capital account that is specifically used for treasury stock transactions; the reason for this segregation is that any subsequent sales of treasury stock for less than the original buy-back price requires the accountant to make up the difference from any gains recorded in this account; if the account is emptied and there is still a difference, then the shortage is made up from the additional paid-in capital account for the same class of stock, and then from retained earnings.