If a corporation has issued only one type, or class, of stock it will be common stock. (Preferred stock is discussed later.) While "common" sounds rather ordinary, it is the common stockholders who elect the board of directors, vote on whether to have a merger with another company, and see their shares of stock increase in value if the corporation is successful.
When an investor gives a corporation money in return for part ownership, the corporation issues a certificate or digital record of ownership interest to the stockholder. This certificate is known as a stock certificate, capital stock, or stock.
The common stockholder has an ownership interest in the corporation; it is not a creditor or lender. Hence, the common stock does not come due or mature. If stockholders want to sell their stock, they must find a buyer usually through the services of a stockbroker or an online app. Nowhere on the stock certificate is it indicated what the stock is worth (or what price was paid to acquire it). In a market of buyers and sellers, the current value of any stock fluctuates moment-by-moment.
A corporation's accounting records are involved in stock transactions only when the corporation is the issuer, seller, or buyer of its own stock. For example, if 500,000 shares of Apple Computer stock are traded on the stock exchange today, and if none of those shares is newly issued, sold, or repurchased by Apple Computer, then Apple Computer's accounting records are not affected. The corporation will go about its routine business operations without even noticing that there were some changes among its stockholders.
Some investors may have large ownership interests in a given corporation, while other investors own a very small part. To keep track of each investor's ownership interest, corporations use a unit of measurement referred to as a share (or share of stock). The number of shares that an investor owns is printed on the investor's stock certificate or digital record. This information is also maintained in the corporate secretary's records, which are separate from the corporation's accounting records.
If an investor owns 1,000 shares and the corporation has issued and has outstanding a total of 100,000 shares, the investor is said to have a 1% ownership interest in the corporation. The other owners have the combined remaining 99% ownership interest.
When a business applies for incorporation to a secretary of state, its approved application will specify the classes (or types) of stock, the par value of the stock, and the number of shares it is authorized to issue. When its articles of incorporation are prepared, a business will often request authorization to issue a larger number of shares than what is immediately needed.
To illustrate, assume that the organizers of a new corporation need to issue 1,000 shares of common stock to get their corporation up and running. However, they foresee a future need to issue additional shares. As a result, they decide that their articles of incorporation should authorize 100,000 shares of common stock, even though only 1,000 shares will be issued at the time that the corporation is formed.
When a corporation sells some of its authorized shares, the shares are described as issued shares. The number of issued shares is often considerably less than the number of authorized shares.
Corporations issue (or sell) shares of stock to obtain cash from investors, to acquire another company (the new shares are given to the owners of the other company in exchange for their ownership interest), to acquire certain assets or services, and as an incentive/reward for key officers of the corporation.
The par value of a share of stock is sometimes defined as the legal capital of a corporation. However, some states allow corporations to issue shares with no par value. If a state requires a par value, the value of common stock is usually an insignificant amount that was required by state laws many years ago. If the common stock has a par value, then whenever a share of stock is issued the par value is recorded in a separate stockholders' equity account in the general ledger. Any proceeds that exceed the par value are credited to another stockholders' equity account. This required accounting (discussed later) means that you can determine the number of issued shares by dividing the balance in the par value account by the par value per share.
If a share of stock has been issued and has not been reacquired by the corporation, it is said to be outstanding. For example, if a corporation initially sells 2,000 shares of its stock to investors, and if the corporation did not reacquire any of this stock, this corporation is said to have 2,000 shares of stock outstanding.
The number of outstanding shares is always less than or equal to the number of issued shares. The number of issued shares is always less than (or equal to) the authorized number of shares. Here is a mathematical presentation:
When a corporation reacquires shares of its own stock and does not retire the shares, the corporation is said to have treasury stock. (Treasury stock will be discussed later.) The number of outstanding shares is equal to the number of issued shares minus the number of treasury shares, as shown here:
Here are the terms in descending order (largest to smallest) based on hypothetical amounts:
* The difference between the issued shares and the outstanding shares is the number of shares of treasury stock (100 shares in this example).
Accounting For Stockholders' Equity
A corporation's balance sheet reports its assets, liabilities, and stockholders' equity. Stockholders' equity is the difference (or residual) of assets minus liabilities.
Because of accounting principles, assets (other than investments in certain securities) are generally reported on the balance sheet at cost (or lower) amounts. As a result, you should not assume that the total amount of stockholders' equity is equal to the current value, or worth, of the corporation. (For a more thorough discussion of the balance sheet, visit our Explanation of Balance Sheet.)
Because of legal requirements, the stockholders' equity section of a corporation's balance sheet is more expansive than the owner's equity section of a sole proprietorship's balance sheet. For example, state laws require that corporations keep the amounts received from investors separate from the amounts earned through business activity. State laws may also require that the par value be reported in a separate account.
Below are the items that a corporation is required to report on its balance sheet in the stockholder's equity section. We will discuss them in the order they would appear on a balance sheet:
- Paid-in capital (also referred to as contributed capital)
- Retained earnings
- Accumulated other comprehensive income
- Treasury stock