Is common stock debit or credit? Common stocks form company equity and are therefore treated as equity in accounting. Companies issue out shares to the public, giving shareholders part-ownership of the company. Owning a share is owning a unit of the company’s capital. Common or ordinary shares and preferred shares are the several types of shares that companies issue to investors.
Debits and credits are used frequently when recording transactions in accounting records. For any transaction, an amount must be entered as a credit in one account (right side of the balance sheet) and as a debit in another account (left side of the balance sheet). This accounting system is known as a double-entry system and provides accuracy in accounting records and financial statements.
How is common stock treated in a double entry system? This article aims to answer the question of whether a common stock is treated as a debit or credit. First, let’s have an understanding of debit and credit entry.
Understanding debit and credit
Numbers are recorded in the debit and credit columns when accounting for business transactions. The debit and credit entries are used to record every transaction that occurs within a business’s chart of accounts. For every transaction reported in the books, a debit entry must have a credit entry that corresponds with it while equaling the same amount. This means that every transaction in accounting has to be exchanged for something else that has the exact same value.
Therefore, for every transaction recorded, the total of debit and credit entries must always equal each other in order for the accounting transaction to be considered balanced. If the accounting transaction is not in balance, it would be difficult to create financial statements. Credit entries increase equity, revenue, or liability accounts and reduce asset or expense accounts. Debit entries, on the other hand, cause an increase in asset or expense accounts and reduce equity, revenue, or liability accounts.
In double-entry accounting, credit entries are designed to always add a negative number to the journal while debit entries add a positive number. Hence, in journal entries, a debit will always be positioned on the left-hand side or column of the ledger and credit will always be positioned on the right-hand side of the ledger.
A debit entry in an account would simply mean a transfer of value to that account, whereas a credit entry would mean a transfer of value from the account. Each transaction in business transfers value from a credit account to a debit account. Hence, when a transaction is made, at least two accounts are affected with a debit or credit entry. Take, for instance, a company issuing out common stocks to shareholders. This transaction will cause a debit in the bank or cash account and a credit in the common stock account.
Conclusively, debits and credits are used in double-entry accounting to record transactions that occur in a company’s chart of accounts. However, the challenge might be understanding which account should be debited and which should be credited. When it comes to equity accounts in double entry accounting; is common stock debit or credit? Let’s look at what equity is in accounting to understand whether common stock should be a debit or credit entry.
Equity in accounting
Is equity a debit or credit entry in accounting? In accounting, equity is recognized as the residual amount that is left after the company’s liabilities are subtracted from its assets. In general, equity represents the amount of money that a company will give to its shareholders in a case of liquidation after the company has settled its debts, the residual amount is the shareholders’ equity.
Equity is one of the basic units for double-entry bookkeeping in accounting. The other basic units are assets and liabilities. An increase in a company’s equity will be a credit balance while a decrease in its equity will be a debit. Because equity only increases and grows in most cases, it is associated with credit entries on the balance sheet.
Likewise, equity on the trial balance usually occurs on the credit side. Though there are some exceptions such as accumulated losses, which are entered as a debit. After every accounting period, companies get the difference between their incomes and expenses and take the residual amount to the retained earnings account (shareholder’s equity account).
A company’s equity will consist of various balances which differ from one company to another. Common stock, however, forms the largest portion of a company’s total equity. It represents the ownership of the company in monetary terms and usually refers to the total number of outstanding shares multiplied by their par value. Let’s look at the common stock and its treatment in accounting.
See also: Expense: Debit or Credit?
What is common stock?
Common stock is a form of corporate equity ownership, a security that represents ownership. Common stockholders elect the board of directors and have voting rights. This security is usually reported in the stockholder’s equity section of a company’s balance sheet which includes the total finance that a company has raised from issuing out its shares.
Common stock in the shareholders’ Equity section of the balance sheet only consists of the balances from ordinary share issuance. It does not involve other shares like preference shares and excludes funds from debtholders. The common stock represents the accounting value of a company’s total number of outstanding shares.
Common shareholders are paid dividends from the company’s profits and have voting rights, allowing them to have a say in the company’s operations. Generally, common stocks on the balance sheet usually represent a company’s ownership in accounting terms.
Companies may issue shares at discount, for instance, as right issue shares, or distribute stock for free like in the case of bonus shares. Some companies may also offer different types of common shares where some come with voting rights, and others don’t.
The common stock accounting treatment is similar to equity because it is a part of a company’s equity. Therefore, an increase in the common stock balance will also cause an increase in the company’s shareholders’ equity. A company’s common stock does not usually decrease, though, it may occur in some instances such as the reacquisition of shares.
Therefore, even if a company issues stock at discount or for free, the common stock account will increase. As long as companies issue their stock to shareholders, this account will increase. That is, the common stock does not necessarily represent cash receipts or total funds. Rather, it shows the value of a company’s outstanding shares in par value.
Related: Revenue debit or credit?
Is common stock a debit or credit?
Common stock is not a debit but a credit entry because it is an equity balance. Recall that, credit entries increase equity, revenue, or liability accounts and reduce asset or expense accounts. Common stock increases in most cases regardless of whether companies issue the shares for free or at discount; thus it is considered to have a natural credit balance. That is, a company’s common stock, as an equity balance, is a credit.
Companies usually receive funds in exchange for the shares they issue out. Therefore, they must record this transaction by entering the amount received as a debit in their bank or cash account and as a credit in their common stock account.
The journal entry for the issuance of common stock will be recorded as follows:
|Bank or Cash A/C||123|
The above journal entry is for when a company issues shares at par value. The par value is the value of a single common share that is set by a corporation’s charter.
Furthermore, there are some companies that may require the shareholders to pay more than the par value. Because the common stock account will not hold any additional amount that is more than the common stock’s par value, the companies must record the extra amount in the share premium account. This account is also known as the additional paid-in capital.
The journal entry to record common shares issued above par value is reported as follows:
|Bank or Cash A/C||AAAA|
|Additional paid-in capital||CCCC|
The same entry above occurs in the case of right or bonus issues. However, in the case of a right or bonus issue, the company must still credit the common stock account with the par value because the shares are issued at discount. The company must record the difference between the par value and actual value as a debit to the share premium account.
The journal entry for this will be reported as follows:
|Bank or Cash A/C||AAAA|
|Additional paid-in capital||BBBB|
As seen in all the journal entries illustrated above, common stock is reported not as a debit but as a credit. However, common stock may be reported as a debit when a company repurchases its shares. In such an instance, the company has to debit the common stock account and credit the treasury stock account. Then, when the company later pays its shareholders, it will debit the treasury account, thus, releasing the balance.
See also: Is common stock a current asset?
Common stock; debit or credit? (examples)
Let’s look at some examples to understand common stock journal entries.
Assume Company XYZ during an accounting period issued 1,000 common stocks at $120 each. Say the company’s common stock par value is $100. If Company XYZ received the funds for the 1000 common stocks issued through the bank. The journal entry for this transaction is reported as follows:
|Common Stock (1,000 x $100)||$100,000|
|Additional paid-in capital||$20,000|
If next year, Company XYZ issues 500 additional common stocks to its shareholders at a discount and charges $90 for the issue of new shares and this transaction occurs through the bank. The journal entry will be accounted for as follows:
|Additional paid-in capital||$5,000|
|Common Stock (500 x $100)||$50,000|
As Company XYZ issued new shares, the company’s number of outstanding shares grows. Also, as seen in the two journal entries illustrated above, common stock is entered as a credit. Therefore, common stock is not a debit but a credit entry.
Related: Common stock: asset or liability?Last Updated on November 8, 2023 by Nansel Nanzip Bongdap
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