Transactions affecting paid-in capital
The following are the main topics to understand for paid-in capital:
Common stock
A company can have more than one class of common stock. It is the unit of ownership that grants a shareholder a right to vote in major corporate events. Normally common stock is registered with a stated par value, which when aggregated for all issued common stock, represents the legal capital of the company.
When a common stock is issued, companies do not normally receive an amount exactly equal to the par value of the stock. In this case, any excess is credited to the additional paid-in capital (APIC). A sample journal entry to record the issuance of a common stock above par is shown below:
| Account | Debit | Credit | Financial statement element |
| Cash | XXX | Asset | |
| Common stock | XXX | Equity | |
| APIC - common stock | XXX | Equity | |
| To record issuance of common stock above par | |||
The credit to common stock represents the par value of the stock issued. Any excess is credited to APIC. In the case of no-par value common stock, the entire proceeds are credited to the common stock account. No-par value common stocks are stocks that are registered without a par value.
Preferred stock
The most significant distinction of a preferred stock versus a common stock is the absence of a right to vote. However, despite this lack of capacity to participate in voting, a preferred stock has certain advantages:
- Preference in liquidation - preferred stock are not subordinate to common stock. Hence, in the event of a liquidation, preferred stockholders will receive its share in the assets before common stockholders.
- Preference in dividend distributions - preferred stockholders receive dividends before common stockholders. The amount of dividends depends on the type of preferred stock they are holding (cumulative or non-cumulative).
The journal entry for the issuance of a preferred stock is the same as for common stock, substituting the preferred stock and APIC - preferred stock accounts for their common stock and APIC - common stock counterparts. The credit to preferred stock represents the par value of the stock issued, and any excess is credited to APIC.
There are two types of preferred stock with regards to its rights to dividends in arrears:
- Cumulative preferred stock, and
- Non-cumulative preferred stock.
Cumulative preferred stock
When a preferred stock is cumulative, it means that each year, preferred stockholders earn the right to be paid preferred dividends in the future, regardless if they have been declared or not. Any undeclared dividends for cumulative preferred stock of prior periods are referred to as dividends in arrears and must be disclosed in the financial statements to provide users of financial statements information about the dividend-paying capacity of the company since these arrears should be settled first before paying dividends to common stockholders.
If the dividends are undeclared, a journal entry does not have to be booked to record dividends in arrears.
Only when a dividend is declared should the company record a dividend payable for all dividends in arrears up to that point.
Non-cumulative preferred stock
When a preferred stock is non-cumulative, it means that preferred stockholders lose the right to be paid a dividend when it is not declared during the year. Journal entries for declared dividends to preference shareholders are the same for common stock and will be discussed under “retained earnings”.
Additional paid-in capital (APIC)
APIC represents the value of shares above the par or stated value. Transactions affecting APIC are generally discussed with the related equity accounts that generated the APIC:
- APIC - common stock - arising from the issue of common stock above par value as discussed in the previous section.
- APIC - preferred stock - arising from the issue of preferred stock above par value as discussed in the previous section.
- APIC - treasury stock - arising from treasury share transactions which will be discussed next.
Treasury stock
These are stocks that have been issued but were subsequently reacquired by the company, making them shares that are issued but not outstanding since the current owners of the shares are the company itself.
When a company has treasury stock, it generally has two options:
- the company can re-sell the shares to external shareholders, in which case it becomes an “outstanding” stock again, or
- the company can retire the shares, in which case the share ceases to be classified as an “issued” stock.
There can be several economic reasons why a repurchase of shares to become treasury shares is necessary such as when the company wants to:
- consolidate ownership by removing smaller shareholders
- improve certain ratios that use issued and outstanding shares as an input, or
- reduce the cost of capital.
Treasury stock is a debit-balance contra-equity account. It is not part of paid-in capital - under the cost method, it’s shown as a separate deduction after paid-in capital and retained earnings, reducing total stockholders’ equity until the shares are reissued or retired.
The most common method for accounting of treasury stock is the cost method under US GAAP. This method debits the treasury stock account with the total cost of the treasury stock regardless of its original issue price.
When treasury shares are later reissued, the difference between the reissue price and their cost is recorded in APIC - treasury stock: reissuing above cost credits APIC - treasury stock, while reissuing below cost debits APIC - treasury stock (and then retained earnings, if APIC - treasury stock isn’t large enough to absorb the difference).
Example: reissuing treasury stock
A company buys back 1,000 shares of its own stock for $20 per share. It later reissues 400 of those shares for $25 per share, and the remaining 600 shares for $15 per share.
- Repurchase: debit treasury stock and credit cash for $20,000 (1,000 shares × $20)
- Reissue the first 400 shares: cash received is $10,000 (400 × $25); the cost of those shares was $8,000 (400 × $20), so the $2,000 excess is credited to APIC - treasury stock
- Reissue the remaining 600 shares: cash received is $9,000 (600 × $15); the cost of those shares was $12,000 (600 × $20), a $3,000 shortfall. The $2,000 balance in APIC - treasury stock absorbs part of it, and the remaining $1,000 is debited to retained earnings
Answer: repurchase - debit treasury stock $20,000, credit cash $20,000. Reissue 400 shares at $25 - debit cash $10,000, credit treasury stock $8,000, credit APIC - treasury stock $2,000. Reissue 600 shares at $15 - debit cash $9,000, debit APIC - treasury stock $2,000, debit retained earnings $1,000, credit treasury stock $12,000.
Stock splits
A stock split has an effect of altering the components of what makes up the company’s share capital in USD (i.e., the number of shares and par value) while retaining its total balance in USD.
Below is a simple illustration of a company’s share capital before and after a 2-for-1 stock split and its effect on its market price per share.
A two-for-one (i.e., 2-for-1) stock split means that for each original share, two new shares will be issued while also splitting the par value in half. One of the most common benefits of a stock split is that it makes the share more accessible to new investors, thus improving liquidity, because it also proportionally reduces the market price per share while maintaining the market capitalization.
In the case of above, each share now costs $3.75 to external shareholders instead of $7.50 per share before the stock split while maintaining the same market capitalization.
Since there is no impact to the company’s common stock in dollar amounts, the recording of a stock split will depend on the record keeping policies of the company but typically a memorandum entry would suffice where the company should note that the previous common stock with the old par value has been canceled and then replaced by the new common stock with the new par value.
For example, a 1-for-2 reverse stock split makes an investor who owns 2 shares end up with 1 share while doubling the market price per share. Companies use reverse splits to raise the per-share price when it risks falling below an exchange’s minimum listing price.
It also has no impact on the total par value in USD and market capitalization, just like a regular stock split.
Stock dividends
A stock dividend doesn’t change total stockholders’ equity - it reclassifies an amount from retained earnings to paid-in capital. How much gets reclassified depends on the size of the dividend:
- Small stock dividend (under 20-25% of the shares outstanding): recorded at the market value of the shares issued. Retained earnings is debited for that market value, common stock is credited for the par value of the new shares, and the excess is credited to APIC - common stock.
- Large stock dividend (20-25% or more of the shares outstanding): recorded at par value instead, since issuing that many new shares is expected to depress the market price. Retained earnings and common stock are both recorded at par value, with no APIC impact.
Either way, total equity doesn’t change - the dividend just moves dollars from retained earnings into paid-in capital. A stock split is different: it doesn’t touch retained earnings or APIC at all, only the number of shares and the par value per share.