Accounting for Stock Transactions

When a corporation is formed, the number of shares legally authorized for issuance is stated in its charter; this is the maximum number of shares that an organization can issue and is referred to as authorized shares. As the corporation sells its stock, the stock is considered issued. The funds raised specifically from stock purchases are paid-in capital. Occasionally, corporations will reacquire stock after it has been issued, which is known as treasury stock. Outstanding stock is the total authorized stock that is issued and currently held by stockholders. In most cases, outstanding shares represent issued shares net of treasury stock.

A stock certificate is issued upon request to stockholders in order to document their ownership. This certificate lists the name of the company, the name of the stockholder, and the number of shares that are owned by the stockholder. The certificate also lists the par value of the stock, which is the value in dollars that is assigned to each share of stock. If the stock is issued without a par value, it is referred to as no-par stock; however, some states require the use of a stated value.

As an owner of a corporation's stock, the holder of a common share is entitled to:

• The right to vote on matters that affect the corporation
• The right to dividends or to share in the distribution of earnings
• The right to the assets of the corporation in the event of a liquidation

However, these rights vary depending on which class of stock the stockholder owns.

There are two classes of stock, common stock and preferred stock. Common stock is the class of stock wherein each share carries equal rights. Preferred stock is the class of stock that carries various rights, such as dividend preference. However, common stock is the default stock class. If a corporation only has one class of stock, it will be common stock. Capital stock is the total amount of a corporation's common stock and preferred stock that the corporation is authorized to issue.

Preferred stockholders have preferential rights, such as the rights to dividends. Dividend rights are stated as dollars per share or as a percent of par. For example, the dividend rights will be shown as "preferred $5 stock, $50 par" or "preferred 7% stock, $50 par." The $5 and 7% represent the dividend amount that is a guarantee of priority to preferred stockholders. (If there is no income, the stockholders will receive no dividends.) Common stockholders will receive a portion of dividends proportionate to the number of shares they own. Dividends received by common stockholders will vary based on the amount of total dividends, the amount paid out to preferred stockholders, and the number of shares outstanding. With preferential rights to dividends, or current preference, the preferred stockholders have a greater chance of receiving dividends than do common stockholders. Another type of preference is participating preference, which allows shareholders of participating preferred stock to receive the preferred dividend amount in addition to a certain portion of company earnings. Also, in the event that the company is liquidated, the participating preferred stockholder may be paid a portion of the net sales price of the company. It is important to note that even with a preference, dividends are determined based on the earnings of the corporation. Therefore, there is no guarantee that dividends will be distributed.

Dividends are authorized by the board of directors. Based on earnings and other factors, there may be years during which the board of directors does not declare a dividend for the stockholders. In such cases, cumulative preferred stock gives the stockholder the right to receive dividends that were not declared or paid in prior years. Noncumulative preferred stockholders do not have these cumulataive preference rights. Cumulative preferred stock that has not been paid in at least one prior period is said to be in arrears. When dividends are in arrears, the cumulative preferred stockholder dividends accumulate until the board of directors issues and declares a dividend large enough to provide an opportunity to catch up. Until the cumulative preferred stockholders have received all of their dividends that are in arrears, the common stockholders will not receive any dividends. Dividends in arrears are also normally disclosed in the notes of the financial statements.

For example, Company ABC is a corporation that has 20,000 shares of cumulative, 3% stock, $100 par, and 50,000 shares of $10 common stock outstanding. The amounts of $40,000, $70,000, and $100,000 are distributed as dividends each year for 3 years.

Once preferred stock dividends are calculated, $60,000 becomes the golden number, or the target amount owed to preferred stockholders each year. In each year that $60,000 is not obtainable, the remaining balance becomes arrears to be moved to the next year. In year 2, the $60,000 threshold is met, and there is room to pull in some of the arrears. While the common stockholders do not see any dividends, they are getting closer as the organization works to catch up with distributions to preferred stockholders. Finally, in year 3 the preferred stockholders are caught up, leaving $30,000 of dividends to be shared among the common stockholders.

Corporations are required to keep track of their stockholders' accounts. In order to do this, many large organizations designate a financial institution, such as a bank, for this purpose.

Stock may be issued or sold by the corporation at an amount different from the par value. The current price at which stock is sold can depend on:

• The financial position, including the earnings and dividend history, of the corporation
• The expectations of investors as it relates to the earning power of the stock
• The general economic and business conditions affecting the corporation

When issuing stock, a premium is present when stock has been sold for a price that is more than its par value. For example, if common stock with a par value of $15 is sold for $25 per share, the premium on the stock sold would be $10. When issuing stock, a discount is present when stock has been sold for a price that is less than its par value. For example, if common stock with a par value of $15 is sold for $10, the discount on the stock sold would be $5. Some states do not allow corporations to sell stock at a discount, while some states will allow it under certain circumstances. To avoid this issue, many companies set their par value at a very low amount, such as $1. This prevents stock from being sold at a discount.

Journal Entries for Premium on Stock

Issuance of Preferred Stock for Cash Journal Entry

Issuance of Common Stock for Land Journal Entry

Journal Entries for No-Par Stock

Issuance of No-Par Common Stock Journal Entry

Issuance of No-Par Common Stock with Stated Value Journal Entry