If you have ever wondered if common stock is an asset or liability, you are not alone. A lot of people seek to invest their money in stocks but most are unsure if the investment will be an asset or a liability. Our discussion shall answer the question is a common stock asset or liability but in order for us to answer this question, let us first understand what an asset or a liability is.
What is an asset?
An asset is any resource that is expected to provide future economic benefits to its owner; either by increasing cash inflows or reducing cash outflows. It is anything physical or intellectual that can be used to get a positive economic value. In simple terms, assets are things that you owed or own.
Assets represent value that can be turned into cash and are majorly classified into tangible and intangible assets. Tangible assets are assets that can be seen and touched hence they are also called physical assets; they include equipment, land, cash, building, etc. Intangible assets are resources that cannot be physically seen hence they are also known as non-physical assets; they include patents, trademarks, copyrights, intellectual property, computer programs, etc.
The major economic benefit that can be derived from assets is usually in the form of an appreciation in market price or value over time. Assets can be owned by individuals, corporate organizations, and even countries. In the case of corporate organizations, they keep a record of their liabilities in their books of account, and on the balance sheet, it is recorded on the left-hand side.
An accounting equation expresses the balance sheet structure of an asset as Assets = Liabilities + Equity
Now that we know what an asset is, let us have a look at what a liability is.
What is a liability?
A liability is a claim on assets by creditors such as bondholders that represents an obligation to make payments in the future either as cash, goods, or services. Simply put, a liability is anything you have borrowed or owe. Therefore both individuals and corporate entities can have a liability.
In the case of corporate entities such as a company, they keep a record of their liabilities in their books of account, and on the balance sheet, it is recorded on the right-hand side. An accounting equation expresses this balance sheet structure of liability as Liabilities = Assets – Equity.
Now that we have understood what both assets and liabilities mean, let us find out what common stock is so that we can determine if it is an asset or a liability.
What is common stock?
Common stock is a single security instrument that represents ownership in a company. It usually gives its owners the right to participate in its issuing company by having voting rights and sometimes, receiving dividend payments too. It is issued by companies who intend to raise capital for business expansion, acquisition of machinery, payment of debts, etc, from its sale.
Apart from voting rights and dividend payments, common stockholders also have a residual claim on the issuing company’s assets in a case whereby the company liquidates. They also have the right to be first offered subsequent shares which the company might issue in the future before the company offers them to the public. Additionally, the stockholders’ liability is limited to their initial investment amount.
Is common stock asset or liability?
Common stock is not an asset, it is also not a liability. Common stock is a financial equity instrument that represents ownership in its issuing company.
Although common stock could be taught of as a liability since its issuing company has to pay dividends to its stockholders and it might also be taught of as an asset since it has some characteristics that provide future economic benefits to its owners such as having the potential to increase in market value and the payment of dividends to its owners. Common stock on the balance sheet is classified as equity or more commonly, as stockholders’ equity.
What is stockholders’ equity?
Stockholders’ equity is the residual claim common stockholders have on assets after the payment of creditors. It is expressed as Stockholders equity = Assets – liabilities. It is also called net worth or net assets or shareholders equity.
It usually consists of share capital which is the capital gotten from the sale of shares and retained earnings which is the income earned by the company through the services or products it offers.
Stockholders equity is the total amount that the business owners have invested into the company which includes: an accumulation of all the income the business has made since inception; all income that has been reinvested since inception; all monies that have been directed invested by the owners and all funds gotten from the sales of equity stocks.
Sources of stockholders’ equity
- Contributed capital includes the common stock’s par value as well as additional paid-up capital and treasury stock. The par value is the face value of the stock. Additional paid-up capital is the excess capital gotten from the sales of stocks. Treasury stock is all previously issued stock that the company has bought back.
- Retained earnings comprise the accumulated net income of the company minus all dividend payments to investors/shareholders.
Common stock: asset or liability?
We have already seen that common stock is neither asset nor liability and that instead, it is equity. However, even though common stock is an equity instrument, it tends to be viewed as an asset by investors who own them. Below, we shall discuss why a common stock is an equity and why it could be considered an asset too.
Common stock as equity
- Buying the stocks of a company represents ownership in the company. The number of stocks you own shows the ownership stake you have in that company. If for example a company issues a thousand (1000) stocks, and you purchase two hundred (200) of these; it means your ownership stake in the company is twenty percent (20%). This means that if the company were to liquidate, you are entitled to get twenty percent from its liquidation.
- Additionally, the fact that common stocks are a source of long-term financing for the issuing company also makes these stocks equity.
- Furthermore, when the issuing company wants to record the funds it has gotten from the sales of stocks, it is recorded under stockholders’ equity as paid-up capital. Also, when the company decides to buy back some of its already issued common stock either as a way to retain more control or to reduce its outstanding stock; the bought-back shares are also recorded under shareholders’ equity as treasury stocks.
Common stock as an asset
Assets are resources that are expected to provide future economic benefits to their owners either by increasing cash inflows or reducing cash outflows. Even though the financial world recognizes common stock as equity, investors who own these stocks largely consider them as an asset due to the following reasons:
- Most common stockholders receive distributions from the issuing companies in which they own stocks in the form of cash dividends. These dividends are paid either quarterly or yearly whenever the issuing company declares dividends.
- Similar to other assets such as land, common stocks when held over time could increase in market value. This means that a stock that was bought for one dollar ($1) today could increase in market value to ten dollars ($10) in say five years especially when its issuing company experiences growth.
- Some investment brokerages accept common stocks as collateral when giving out loans. Owning common stocks is therefore considered assets since they represent creditworthiness.
Frequently asked questions
Is common stock an asset?
Common stock is equity. However, due to the fact that their holders may receive dividend payments, use them as collateral, and could make capital gains from them; common stock can be considered an asset by the stockholder.
Why is common stock equity?
Common stock is equity because it is a security instrument that represents ownership in its issuing company.
We have discussed the question is a common stock asset or liability, looking at the reasons why it is considered equity in the financial world due to how it is recorded in the balance sheet. We have also seen that part of why it is considered equity is due to its feature of having no maturity date, making it a source of permanent capital to the issuing company. Furthermore, we have also seen some attributes of common stocks which are akin to that of assets and why stockholders commonly classify these stocks as assets.
Whether a common stock is an asset, liability or equity largely depends on if you are the issuing company or a stockholder. However, the general agreement in finance is that common stock is neither asset nor liability, it is instead, equity.