Is capital stock a debit or credit? Capital stock refers to the maximum number of shares that could be issued by a company. The two main types of shares that companies issue are preferred stock and common stock; with common stock being the most commonly issued. A company’s capital stock is reported on its balance sheet under the shareholder’s equity section along with paid-in capital and retained earnings. Companies generally issue shares as a means of raising funds for various business activities such as mergers and acquisitions (M&A), research and development (R&D), expansions, marketing, etc.
When companies issue shares, they have to record the share issue in their financial records. The financial records for transactions occurring in a company are known as journal entries and these journal entries are made by debiting and crediting various accounts. Here, our discussion shall be geared towards understanding whether the capital stock is a debit or credit.
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What is capital stock?
Capital stock refers to the maximum number of both preferred and common stock that can be issued by a company. This maximum number of shares is referred to as authorized stock and the shares that have already been issued and are owned by shareholders are known as outstanding stock.
The authorized stock is usually predetermined by a company’s board of directors and included in the company’s Articles of Association (AOA). Companies can issue more capital stock over time provided it does not exceed the approved authorized shares. Most companies authorize a larger number of shares than they issue so as to minimize the legal costs incurred from the subsequent issuing of more capital stock.
When it comes to the issuing of shares, most companies issue common stock with only a small percentage of companies issuing preferred stock. The total number of shares that have been issued by a company is usually reported in its balance sheet under the equity section. The income generated from the sale of stock is usually reported in two different accounts; share capital and paid-in capital.
The share capital account reports the stock’s par value while the paid-in capital account reports any additional income generated from the sale of stocks asides from its par value. By issuing capital stock, the company can raise funds without having to outrightly collect a loan from the bank or incur debt. The funds raised from the share sale are used for various business activities such as the purchase of assets, settlement of debt, expansion, increasing working capital, etc.
Additionally, depending on the type of shares the company chooses to issue, it may have to relinquish some control to the shareholders. Typically, preferred stock does not come with voting rights but common stock confers voting rights on its holders. Investors mainly purchase stocks as a means of investing in a business and also, to receive a return on their equity through the distributions they may receive in the form of dividend payments.
Companies can choose to issue all their capital stock at once, in which case, their authorized and issued shares will be equal. Generally, however, companies issue only part of their authorized stock and may even choose to buy back some of their outstanding stock to increase the value of their shares.
Understanding debits and credits for capital stock
Any change in the capital stock of a company occurs as a result of a business transaction. All transactions that occur in companies are recorded based on the rules of debits and credits. In accounting debit and credit do not just mean subtracting and adding respectively; instead, both debits and credits could mean a subtraction from or an addition to an account. Hence whether a debit or credit will be an increase or a decrease in the balance of an account depends on the type of account.
An account is considered a debit or credit account based on its business nature, this aids in determining whether a transactional increase or decrease to an account will be a debit or a credit. For the capital stock account which is an equity account, it decreases with a debit and increases with a credit. Other accounts that decrease with a debit and increase with a credit are the liabilities and revenue accounts.
Accounting rules place debits on the left column and credits on the right column and this is applicable in the layout for both the balance sheet and journal entries. Furthermore, all transactions that occur are recorded in pairs; debit and credit are made side by side for every transaction. For the capital stock account, a credit to capital stock results in an equal but opposite debit to the cash account. We shall discuss more on this double-entry for capital stock transactions hereafter.
See also: Is Capital Debit or Credit?
Is capital stock a debit or credit?
Like other equity accounts such as retained earnings, the capital stock has a natural credit balance. Therefore a capital stock is not a debit, instead, it is a credit.
As mentioned earlier, capital stock refers to either preferred or common stock. Hence whenever companies issue any of these shares, it will be recorded as a credit (increase) in the capital stock account. When companies buy back some of their already issued shares, it is recorded as a debit (decrease) in the capital stock account. Let us take a look at the various journal entries for the capital stock account.
Debit and credit journal entries for the capital stock
The general rule for identifying whether a transaction is a debit or a credit to a particular account is to first determine whether it is a debit or credit account. Debit accounts increase with a debit while credit accounts increase with a credit. The capital stock account which is a credit account increases with a credit and decreases with a debit. All accounts that contain a credit balance increase when a credit entry is added to the and conversely decrease when a debit entry is added to them.
For example, if Apple issues 5 million preferred stock at a par value of $1. It means Apple will realize $5,000,000 from the sale. The journal entry to record that transaction will involve a debit to the cash account and a credit to the capital stock (preferred stock) account as shown below.
Debit and credit journal entry for capital stock issued at par value
This entry indicates an increase to both the cash and capital stock accounts to the tune of 5 million. Furthermore, if Apple decides to sell the preferred stock that has a par value of $1 for $3 per share, it means that aside from the money received as the stock’s par value, they have also received additional paid-in capital. In this case, three accounts will be required to record the transaction. and the journal entry to record the transaction will be as shown in the table below:
Debit and credit journal entry for capital stock issued above par value
Debit and credit journal entry for capital stock issued in exchange for services rendered
There are circumstances in which a company may decide to pay their service providers in stocks instead of cash. This is mainly done when the company wants to maintain the working capital it has while increasing its outstanding shares. In such a situation, the value of the services received becomes the value of the stocks.
For instance, if a tile manufacturing company engages the services of an attorney who charged them $10,000 but instead of cash payments, they decide to give him common stocks in exchange for his services, the company will record the transaction as follows:
If the value of the service received is higher than the par value of the stocks issued to the service providers, then the journal entry for the transaction will be the same as the table showing the debit and credit journal entries for capital stock issued above par value. Furthermore, companies sometimes also pay for assets using stocks.
See also: Is Depreciation Expense Debit or Credit?
Is capital stock a debit or credit? In accounting, the capital stock has a natural credit balance, this is true for all equity accounts. Capital stock is therefore a credit and not a debit. The capital stock represents the maximum number of shares that can be issued by a company and is recorded in the balance sheet under the equity section. The capital stock comprises all preferred and common stock that has been issued by a company. The issue of capital stock is mostly done as a means of raising funds for various operational projects of the company.
Crediting the capital stock account increases its balance while debiting it decreases the balance. Double entries are used when making journal entries for capital stock to ensure accurate, legal, and balanced financial reports and records of transactions involving the capital stock account.
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