Issuance of Common Stock example

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1 Issuance of Common Stock example Let's assume that a company wants to raise $10,000 through the issuance of common stock. At the time the stock is sold the market price is $50 per share. the company will, therefore, have to issue 200 shares. Let us also assume that the par value of the stock is $10. Here is the journal entry that the company will make following the sale of the shares: Common Stock (200 shares x $10)) 2,000 Add l Paid in Capital (10,000-2,000) 8,000 The journal entry involves the following aspects: 1. Cash is increased by the number of shares sold multiplied by the market price of the stock to reflect the receipt of the proceeds 2. Stockholder's equity is increased by $10,000 to reflect the issuance of the stock. This total is divided between the common stock account and the additional paid in capital account. Both of these are stockholder's equity accounts. 3. The common stock account is increased by the par value multiplied by the number of shares sold. The par value is an arbitrary amount set by the board of directors when the class of stock is authorized by the shareholders for issuance. 4. The additional paid-in-capital account is increased by the excess of the proceeds from the stock sale less that portion of the proceeds credited to the common stock account. Common stock can also be authorized as no par. In this case, no par value is assigned to the shares. From an accounting standpoint, the only effect of this designation is that the common stock account is credited for the full amount of the proceeds and no additional paid-in-capital account exists as follows: Common Stock (200 shares x $50)) 10,000 A third form for the stock is no par with a stated value. From an accounting standpoint, stated value is treated the same way as par value. For example, assume that the common stock in this example is no par stock with a stated value of $5. The journal entry for the stock issuance would be as follows: Common Stock (200 shares x $5)) 1,000 Add l Paid in Capital (10,000-1,000) 9,000 Stock issuance costs: When companies issue common stock, the stock is sold through brokers to their retail or institutional clients. These brokers earn a fee for their services and the proceeds received by the company is reduced accordingly. There are two ways in which these stock issuance costs can be accounted for under GAAP.

2 1. Treat the issue costs as a reduction of the amounts paid in. The debit to cash and the credit to additional paid-in-capital are reduced accordingly. This method results in a smaller increase in stockholder's equity upon issuance of the shares. 2. Capitalize the amount as an organizational cost on the balance sheet and amortize the this intangible asset similarly to the amortization of goodwill. This method results in a greater increase in stockholder's equity initially and reduced profitability in the future as the amortization expense is recorded.

3 Accounting for stock repurchases (treasury stock) The following example illustrates the accounting for stock repurchases (treasury stock) utilizing the cost method. This is the most common approach. Under this method, an account called treasury stock is debited for the cost of the shares repurchased. This treasury stock account is a contra-equity account. That means, it is included in stockholder's equity, but is reflected as a negative amount (hence the use of the word "contra"). When the shares are subsequently re-issued, treasury stock is credited for the cost of the shares and any difference between the re-issue price and this cost is reflected as an adjustment to additional paid-in-capital form treasury stock. Assume that a company repurchases 1,000 shares at a current market price of $25 per share. The journal entry the company will make is, Treasury stock (1,000 x 25) 25,000 Cash 25,000 If 500 shares are subsequently sold at a market price of $30, the journal entry to reflect this sale is as follows: Cash (500 x 30) 15,000 Treasury stock (500 x 25) 12,500 Additional paid-in-capital 2,500 If the resale price is less than the original purchase price, additional paid-incapital is debited and if there is not a sufficient balance in the additional paid-incapital account to absorb the debit, retained earnings is debited for the excess.

4 Accounting for Stock Dividends The accounting for stock dividends is divided into two categories: small stock dividends (generally less than 20-25% of the outstanding shares) and large stock dividends (greater than 25% of the outstanding shares). Furthermore, two dates are important: the declaration date (when the dividend is declared to be paid by the board of directors) and the date of distribution (then the chares are actually sent to the shareholders). Small stock dividends. When a company declares a small stock dividend, retained earnings is debited for the market value of the shares to be distributed. Since new shares are to be issued, shareholder's equity must be increased to reflect this and the credit to common stock and additional paid-in-capital is the same as would be made had the firm sold stock. For example, assume that a company has 100,000 shares outstanding and declares a 10% stock dividend. The company will issue 10,000 shares (100,000 shares x 10%) as a dividend to existing shareholders. Also assume that the market value of the stock is $20 per share and that its par value is $5. The required journal entries are as follows: Declaration date Retained earnings (10,000 x $20) 200,000 Common stock dividend distributable 50,000 Additional paid-in-capital 150,000 Distribution date Common stock dividend distributable 50,000 Common stock 50,000 Large stock dividends. When a company declares a large stock dividend, retained earnings is debited for the par value of the shares to be distributed and the additional paid-in-capital account is not affected. For example, assume that the company in our previous example declares a 50% stock dividend. The company will issue 50,000 shares (100,000 shares x 50%) as a dividend to existing shareholders. The required journal entries are as follows: Declaration date Retained earnings (50,000 x $5) 250,000

5 Common stock dividend distributable 250,000 Distribution date Common stock dividend distributable 250,000 Common stock 250,000

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