The ownership structure of companies differs from other businesses. Companies have shares that allow holders to become part-owner of the company. Usually, more shares come with higher control over the company’s operations. A shareholder that owns 50% or more of a company’s total stocks can control its operations.
A share is a unit of capital for a company. There are several types of shares that companies may have. The most common of these include common or ordinary shares.
However, they may also consist of preferred shares and other types. For companies, the accounting for common stock is straightforward as it forms a company’s equity. However, it is crucial to understand what equity and common stock are.
What is Equity?
Defining equity requires the definition of assets and liabilities. Assets are resources that companies own or control. These resources must have future positive economic benefits associated with them. In contrast, liabilities involve a company’s obligations. These have adverse economic benefits related to them in the future.
Equity is the residual amount after subtracting a company’s liabilities from its assets. However, that is the accounting definition for equity. In general, equity represents the amount of money that a company’s shareholders will receive if its assets get liquidated. After paying all of a company’s debts from those assets, the residual amount will be shareholders’ equity.
In accounting, equity is one of the three basic units for double-entry bookkeeping. The other two include assets and liabilities. When a company increases its equity, it is a credit. In contrast, a decrease in a company’s equity is a debit. In most circumstances, equity-only grows and is, therefore, associated with credit entries.
Similarly, on the trial balance, equity balances usually occur on the credit side. There are some exceptions to that case, such as accumulated losses, which a debit. Similarly, income and expenses also fall under equity as both of these affect a company’s equity. After every accounting period, companies find the difference between their incomes and expenses. Then, they take the residual amount to the retained earnings account.
What is Common Stock?
A company’s equity will consist of various balances. These balances will differ from one company to another. Usually, however, common stock or ordinary stock forms the largest portion of a company’s total equity. This amount represents the ownership of the company in monetary terms. Usually, it refers to the total outstanding number of shares multiplied by their par value.
Common stock appears in a company’s shareholders’ equity section. It includes the total finance a company has raised from issuing its shares.
However, it only consists of the balances from ordinary share issuance. It does not involve other shares, such as preference shares. Similarly, it also excludes funds from debtholders, which is a company’s liability.
However, common shares don’t necessarily represent the overall balance payable to shareholders. When a company liquidates, its assets will get sold at lower prices. After repaying the company’s liabilities from its assets, the residual amount may not be the same as its equity. Instead, common stock represents the accounting value of a company’s total outstanding number of shares.
Common shareholders also get a part of a company’s profits through dividends. However, these dividends depend on a company’s retention policy. Furthermore, common stocks also come with voting rights, allowing shareholders a say in a company’s operations. Overall, common stocks represent a company’s ownership in accounting terms on the balance sheet.
What is the accounting treatment for Common Stock?
The accounting treatment for common stock is similar to equity. Common stock is a part of a company’s equity. Therefore, an increase in common stock balance will also grow the company’s shareholders’ equity. Usually, a company’s common stock does not decrease. However, it may occur in some cases, for example, due to the reacquisition of shares.
As mentioned, common stock only represents the accounting value of a company’s ordinary shares. In some cases, it does not represent the total value received from shareholders. Even if a company issues stock at discount or for free, this account will increase. As long as companies distribute their stock to shareholders, this account will fluctuate.
Therefore, the common stock does not necessarily represent cash receipts or total funds. Instead, it shows the value of a company’s outstanding shares in par value. There are some cases where a company may issue shares at discount, for example, right issue shares. Similarly, companies may also distribute stock for free in case of bonus shares.
Some companies may also offer different types of common shares. Some come with voting rights, while others don’t. However, this classification does not affect how companies account for these shares. Therefore, common stocks also don’t represent the voting rights of a company’s shareholders. Similarly, both shares come with the same dividend payouts, and the accounting treatment will remain the same.
Is Common Stock a debit or a credit?
Common stock is an equity balance. As mentioned, this account increases in most cases. Even when companies issue shares for free or at discount, the account balance will grow.
As an equity balance, a company’s common stock is credit. As mentioned, however, this account may also decrease, which will make it a debit entry. However, these cases are rare.
Usually, when a company issues shares, it receives funds in exchange. Therefore, companies must record this amount by debiting their bank or cash account. On the other hand, it must credit its common stock account. The journal entry for issuance of common stock will be as follows.
|Bank or Cash||XXXX|
However, the above entry is for when a company issues shares at par value. Some companies may also require shareholders to pay more than the par value. However, the common stock account will not hold any additional amount more than the common stock’s par value. Instead, companies must take the extra amount to the share premium account (also known as additional paid-in capital).
The journal entries to record a share issue above par value is as follows.
|Bank or Cash||XXXX|
|Additional Paid-in Capital||XXXX|
The same occurs in the case of right or bonus issues. However, since these are shares issued at discount, companies must still credit the common stock account with the par value. Instead, they must debit the difference between the par value and actual value to the share premium account. The journal entries will be as follows.
|Bank or Cash||XXXX|
|Additional Paid-in Capital||XXXX|
In all of the above cases, common stock is a credit. However, it may also be a debit when a company repurchases its shares. In those cases, the company must debit the common stock account and credit the treasury stock account. Later, when the company pays its shareholders, it will debit the treasury account, releasing the balance.
A company, ABC Co., issued 1,000 common stocks at $120 each during an accounting period. The company’s common stock par value is $100. Similarly, ABC Co. received the funds through the bank. Therefore, the accounting treatment for the transaction will be as follows.
|Common Stock (1,000 x $100)||$ 100,000|
|Additional paid-in capital||$ 20,000|
Next year, the company issued 500 additional common stocks at a discount to its shareholders. ABC Co. charged $90 for the issue of new shares. The transaction occurred through the bank. Therefore, the accounting treatment will be as follows.
|Additional paid-in capital||$ 5,000|
|Common Stock (500 x $100)||$ 50,000|
In both of the above circumstances, ABC Co. issued new shares. Therefore, the company’s number of outstanding shares grew. In both cases, common stock was a credit.
Common stock refers to a company’s accounting value of its total number of outstanding shares. It does not represent the funds a company receives or the voting rights associated with the stock.
Similarly, it is a part of a company’s shareholders’ equity on the balance sheet. Usually, common stock is a credit in accounting. In some circumstances, however, it may also be a debit.