12.1 Issuance of stock

Corporations issue different types of stock to raise capital and structure ownership. Common stock represents basic ownership, while preferred stock offers special rights. Understanding these distinctions is crucial for financial reporting and analysis.

Accounting for stock issuance involves recording transactions based on factors like par value and issuance costs. Proper accounting ensures accurate financial statements and helps stakeholders assess a company's equity structure and potential dilutive effects.

Types of stock

• In the context of Intermediate Financial Accounting, understanding the different types of stock a corporation can issue is crucial for proper financial reporting and analysis
• The two main types of stock are common stock and preferred stock, each with distinct characteristics, rights, and accounting treatments

Common stock

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• Represents the residual ownership interest in a corporation after satisfying all other claims (such as liabilities and preferred stock)
• Entitles holders to voting rights, allowing them to elect the board of directors and vote on major corporate decisions
• Dividends on common stock are not guaranteed and are paid at the discretion of the board of directors
• In the event of liquidation, common stockholders have the lowest priority in receiving assets and are entitled to the residual assets after all other claims have been satisfied

Preferred stock

• A class of stock that provides certain preferences and rights over common stock
• Typically entitles holders to a fixed dividend rate, which must be paid before any dividends are distributed to common stockholders
• In the event of liquidation, preferred stockholders have a higher claim on assets than common stockholders but a lower claim than creditors
• Preferred stock may be cumulative (dividends accumulate if not paid) or non-cumulative (dividends do not accumulate if not paid)
• Preferred stock may also have other features, such as convertibility into common stock or callable provisions

Differences between common and preferred stock

• Dividend priority: Preferred stockholders receive dividends before common stockholders
• Dividend guarantee: Preferred stock dividends are typically fixed, while common stock dividends are not guaranteed
• Voting rights: Common stockholders generally have voting rights, while preferred stockholders may have limited or no voting rights
• Liquidation preference: In the event of liquidation, preferred stockholders have a higher claim on assets than common stockholders
• Potential for capital appreciation: Common stock has a higher potential for capital appreciation as the company grows, while preferred stock appreciation is limited

Accounting for issuance of stock

• When a corporation issues stock, it must properly account for the transaction in its financial statements
• The accounting treatment depends on factors such as the type of stock issued, the presence of par value, and any issuance costs incurred

Par value vs no par value stock

• Par value is a nominal value assigned to a share of stock, which is often a small amount (such as $0.01 per share)
• Stock may be issued with or without par value, depending on state laws and corporate charter
• When stock has a par value, the par value is recorded in the common stock account, and any excess over par is recorded in the additional paid-in capital (APIC) account
• When stock has no par value, the entire proceeds from the issuance are recorded in the common stock account

Journal entries for issuing stock

• When stock is issued, the company records a debit to the Cash account (or other assets received) and a credit to the Common Stock account (for par value) and the APIC account (for any excess over par)
• Example: If a company issues 1,000 shares of $1 par value common stock at$10 per share, the journal entry would be:

  Debit: Cash $10,000
  Credit: Common Stock $1,000
  Credit: APIC $9,000
  

Issuance costs of stock

• Costs incurred in connection with the issuance of stock, such as underwriting fees, legal fees, and printing costs, are recorded as a reduction of the APIC account
• These costs are not expensed on the income statement but rather reduce the net proceeds received from the stock issuance
• Example: If the company incurs $500 in issuance costs for the stock issuance mentioned above, the journal entry would be:

  Debit: APIC $500
  Credit: Cash $500
  

Stock issuance above and below par

• When stock is issued at a price above or below its par value, the difference is recorded in the APIC account
• The accounting treatment for premiums (excess over par) and discounts (deficiency below par) ensures that the par value of the stock is maintained in the Common Stock account

Issuance of stock above par

• When stock is issued at a price above par value, the excess is recorded as a credit to the APIC account
• Example: If a company issues 1,000 shares of $1 par value common stock at$12 per share, the journal entry would be:

  Debit: Cash $12,000
  Credit: Common Stock $1,000
  Credit: APIC $11,000
  

Issuance of stock below par

• In some jurisdictions, companies are allowed to issue stock below par value
• When stock is issued at a price below par value, the deficiency is recorded as a debit to the APIC account
• Example: If a company issues 1,000 shares of $1 par value common stock at$0.80 per share, the journal entry would be:

  Debit: Cash $800
  Debit: APIC $200
  Credit: Common Stock $1,000
  

Accounting treatment for premiums and discounts

• Premiums and discounts on stock issuance are recorded in the APIC account to maintain the integrity of the Common Stock account at par value
• The APIC account is a component of stockholders' equity and represents the total amount paid by investors in excess of the par value of the stock

Stock subscriptions

• A stock subscription is a contract between a corporation and an investor, where the investor agrees to purchase a certain number of shares at a specified price
• Stock subscriptions are often used when a company is raising capital and wants to ensure a minimum level of investment before issuing the stock

Stock subscription process

• The stock subscription process typically involves the following steps:
  1. The corporation offers stock subscriptions to potential investors
  2. Investors agree to purchase a specific number of shares at a predetermined price
  3. The corporation collects the subscription payments from investors
  4. Once the subscription is complete, the corporation issues the stock to the investors

Accounting for stock subscriptions

• When a stock subscription is received, the corporation records a debit to the Stock Subscriptions Receivable account and a credit to the Stock Subscriptions account
• As the corporation collects the subscription payments, it debits the Cash account and credits the Stock Subscriptions Receivable account
• Once the subscription is complete and the stock is issued, the corporation debits the Stock Subscriptions account and credits the Common Stock and APIC accounts (if applicable)

Journal entries for stock subscriptions

• Example: If a company receives subscriptions for 1,000 shares of $1 par value common stock at$10 per share, the journal entries would be:
  1. Upon receiving the subscriptions:

     Debit: Stock Subscriptions Receivable $10,000
     Credit: Stock Subscriptions $10,000
     

  2. Upon collecting the subscription payments:

     Debit: Cash $10,000
     Credit: Stock Subscriptions Receivable $10,000
     

  3. Upon issuing the stock:

     Debit: Stock Subscriptions $10,000
     Credit: Common Stock $1,000
     Credit: APIC $9,000
     

Stock options and warrants

• Stock options and warrants are contracts that give the holder the right, but not the obligation, to purchase a specified number of shares at a predetermined price (the exercise price) within a certain time period
• These instruments are often used as a form of compensation for employees or as a sweetener for investors

Characteristics of stock options and warrants

• Exercise price: The price at which the holder can purchase the underlying stock
• Expiration date: The date by which the holder must exercise the option or warrant
• Vesting period (for stock options): The period during which the employee must remain with the company before the options can be exercised
• Warrants are typically issued to investors, while stock options are often granted to employees as part of their compensation package

Accounting for stock options and warrants

• When stock options or warrants are granted, the company must determine their fair value using an option pricing model (such as the Black-Scholes model)
• The fair value of the options or warrants is recorded as a compensation expense over the vesting period (for employee stock options) or as a reduction of the proceeds received from the issuance (for warrants)
• When the options or warrants are exercised, the company records a debit to the Cash account and a credit to the Common Stock and APIC accounts (if applicable)

Dilutive effect of options and warrants

• Stock options and warrants can have a dilutive effect on the company's earnings per share (EPS) if the exercise price is lower than the current market price of the stock
• Diluted EPS takes into account the potential impact of options and warrants on the company's outstanding shares and net income
• Companies must disclose the dilutive effect of options and warrants in their financial statements, as it provides investors with a more accurate picture of the company's potential future share count and EPS

Stock splits and stock dividends

• Stock splits and stock dividends are corporate actions that increase the number of outstanding shares without changing the company's total stockholders' equity
• These actions are often undertaken to make the stock more affordable and attractive to a broader range of investors

Stock splits vs stock dividends

• Stock splits: A stock split is a corporate action that increases the number of outstanding shares by issuing additional shares to existing stockholders in a proportional manner (such as a 2-for-1 split)
  • In a stock split, the par value per share is reduced proportionately to maintain the total par value of the outstanding shares
  • Example: In a 2-for-1 stock split, a stockholder with 100 shares of $1 par value stock would receive an additional 100 shares, and the par value would be reduced to$0.50 per share
• Stock dividends: A stock dividend is a corporate action that issues additional shares to existing stockholders in proportion to their current holdings (such as a 10% stock dividend)
  • Unlike a stock split, a stock dividend does not change the par value per share
  • Example: In a 10% stock dividend, a stockholder with 100 shares would receive an additional 10 shares, while the par value per share remains unchanged

Accounting for stock splits

• Stock splits do not require a journal entry, as they do not change the total stockholders' equity
• However, the company must update its records to reflect the new number of outstanding shares and the reduced par value per share
• The company should also disclose the stock split in its financial statements and notes

Accounting for stock dividends

• When a stock dividend is declared, the company records a debit to the Retained Earnings account and a credit to the Stock Dividends Distributable account
• When the stock dividend is issued, the company records a debit to the Stock Dividends Distributable account and a credit to the Common Stock and APIC accounts (if applicable)
• The amount transferred from Retained Earnings to the Stock Dividends Distributable account is based on the market value of the shares issued as a dividend
• Example: If a company declares a 10% stock dividend when the market value of its stock is $20 per share and has 1,000 shares outstanding, the journal entries would be:
  1. Upon declaration of the stock dividend:

     Debit: Retained Earnings $2,000
     Credit: Stock Dividends Distributable $2,000
     

  2. Upon issuance of the stock dividend (assuming a par value of $1 per share):

     Debit: Stock Dividends Distributable $2,000
     Credit: Common Stock $100
     Credit: APIC $1,900
     

Disclosure requirements

• Companies must provide adequate disclosure of their stock issuance, stock options and warrants, and other stock-related transactions in their financial statements and notes
• Proper disclosure ensures that investors and other stakeholders have a clear understanding of the company's equity structure and potential dilutive effects

Financial statement presentation of stock issuance

• In the balance sheet, the company should present the par value of the outstanding stock in the Common Stock account and any excess over par in the APIC account
• If the company has preferred stock, it should be presented separately from common stock in the stockholders' equity section
• The company should also disclose the number of authorized, issued, and outstanding shares for each class of stock

Notes to financial statements for stock transactions

• In the notes to the financial statements, the company should provide a detailed description of its stock issuance, including:
  • The number of shares issued
  • The par value and issue price per share
  • The total proceeds received from the issuance
  • Any issuance costs incurred
• The company should also disclose information about stock splits, stock dividends, and other stock-related transactions, including the dates and terms of these actions

Disclosure of stock options and warrants

• Companies must disclose information about their stock options and warrants, including:
  • The number of options or warrants outstanding
  • The exercise prices and expiration dates
  • The vesting periods (for stock options)
  • The fair value of the options or warrants and the method used to determine the fair value
  • The dilutive effect of the options or warrants on the company's EPS
• These disclosures help investors assess the potential impact of stock options and warrants on the company's future share count and financial performance