Navigating the Waters of Issuing Stock: A Comprehensive Guide to Stock Issuance and Accounting

Priscilla Wolfe
Jan 13, 2024
5 min read

Updated: Aug 1

Issuing stock is a pivotal moment for companies seeking to raise capital and fuel their growth. However, the process involves more than just allocating shares; it requires meticulous attention to accounting principles to ensure transparency, compliance, and accurate financial reporting. In this guide, we will explore the intricacies of issuing stock and the corresponding accounting procedures.

Issuing Stock: A Strategic Move

1. Types of Stock Issuance:

Common Stock: Represents ownership in the company with voting rights.
Preferred Stock: Carries additional privileges, such as priority in dividend distribution.
Receiving money from the public and issuing them a stock certificate. (A legal document which is considered to be evidence of ownership of shares)

2. Reasons for Stock Issuance:

Raising Capital: Companies issue stock to secure funds for expansion, research, development, or debt repayment.
Employee Incentives: Stock options or grants are often used to attract and retain talented employees.
Mergers and Acquisitions: Stock can be part of the currency used in acquiring or merging with other companies.

Stock Issuance Process:

1. Authorization and Board Approval:

The board of directors must authorize the issuance of new shares, defining the type and quantity of stock to be issued

2. Valuation and Pricing:

Determining the value of the shares is crucial. Companies may conduct a valuation to establish a fair market value per share.
- Payback Period Formula = Initial Investment/Net Annual Cash Flow (Time required to recover initial costs and expenses)
- PE Ratio= Price Per Share/Earnings Per Share (The number of yearly share earnings it will take to recover the price paid per share)
- See Also: Black Scholes Calculator

3. Legal Compliance:

Ensure compliance with regulatory requirements and securities laws. This often involves filing necessary documents with regulatory bodies.

4. Offering and Subscription:

Companies may offer the new shares to existing shareholders, employees, or the public through various methods, such as private placements or initial public offerings (IPOs).

5. Issuing Stock Certificates:

Physical or electronic stock certificates are issued to shareholders, documenting their ownership stake.

Stock Issuance Accounting:

1. Recording the Transaction:

The issuance is recorded in the company's general ledger. Common journal entries include crediting the common stock equity or preferred stock equity account and debiting the cash or contributed capital account.

2. Additional Paid-In Capital:

The amount received above the par value of the stock is recorded as additional paid-in capital equity. This represents the premium paid by investors for the shares.
Journal Entry Debit Cash Account and Credit Common Stock (par) and APIC (price-par)

3. Treasury Stock:

If a company repurchases its own shares or shares are employee related stock options (should be less than 10% of net income), they are classified as treasury stock. Treasury stockholders have no voting rights. The cost of repurchase is deducted from stockholders' equity. Treasury Stock is a contra equity account. Two ways of accounting for treasury stock are:
1) Cost Method-The cost method of accounting values treasury stock according to the price the company paid to repurchase the shares, ignoring par value.
2) Par Value Method: shares are valued according to their nominal or original value as stated in the corporate charter.
- Journal Entry for a repurchase is Debit Treasury Stock, Debit APIC and Credit Cash Account.

4. Disclosures in Financial Statements:

Comprehensive disclosure is essential in financial statements, outlining the details of the stock issuance, terms, and any potential impact on financial performance.

Common Stock and Treasury Stock on the Balance Sheet

Challenges and Best Practices:

1. Dilution Considerations:

Issuing additional shares may dilute existing shareholders' ownership. Companies must carefully assess and communicate the potential dilution impact.

2. Fair Value Assessment:

Ensuring that the stock is issued at a fair value is critical for transparency and compliance. Regular valuations may be necessary.

3. Stock-Based Compensation:

Accounting for stock options or grants to employees involves recognizing the fair value of the options as an expense over the vesting period.
Stock based compensation, under US GAAP, is recognized as a non-cash expense on the income statement.
- SBC to direct labor is allocated to COGS
- SBC to R&D engineers is included within R&D expenses
- SBC for management and sales or marketing is included in SG&A/administrative expenses
Restricted Stock-employees cannot sell their shares for a service period of 3 years and vesting occurs only if the employee stays with the company for 2 years.
- The Journal Entry for Restricted Stock, on the grant date is a Debit to Treasury Stock Contra Account Unearned Compensation and Credit Common Stock and APIC (the SBC value will be recognized on the income statement over each service period at current share price)
- The Journal Entry for each service period is Debit SBC Expense or COGS and Credit the Treasury Stock Contra Account Unearned Compensation
- If the employees stock option is not 'vested' and forfeited, a reversing Journal Entry would be Debit Treasury Stock Contra Account Unearned Compensation and Credit SBC Expense or COGS.
Stock Option-employees There is no Journal Entry at the grant date. example: $10 per share
- The stocks are vested for 3 years, 1/3 each year $5 per share. After year 1 and 2 the Journal Entry is a Debit to SBC Expense or COGS and a Credit to APIC-Stock Options.
- On year 3, the day the stock options vest, all option holders exercise their options at $20 per share the Journal Entry is a Debit to Asset Option Proceeds (Cash) for the amount at the grant date, and a Debit to APIC-Stock Options for the total amount vested each year, Credit both to Common Stock and APIC-Common Stock.

Conclusion:

Issuing stock is a strategic financial move that requires careful planning, legal compliance, and accurate accounting. By understanding the intricacies of the stock issuance process and following best practices in accounting, companies can not only raise capital but also maintain transparency and foster investor confidence. As companies navigate the complexities of issuing stock, a well-executed strategy and adherence to accounting standards will contribute to the long-term success of the business.

How is the sale of common stock taxed?

Generally, any profit you make on the sale of a stock is taxable at either 0%, 15% or 20% if you held the shares for more than a year it is a long term capital gain with a different flat rate of taxation on the gain, or at your ordinary tax rate if you held the shares for a year or less short term gain taxable at an individual's marginal tax rate. Any dividends you receive from a stock are also usually taxable.

Note: Dividend Payouts should be recorded to a separate Dividend Paid Equity Account (per stockholder). Retained Earnings should be reserved to account for profits and losses from previous years, without adjustments, and used in calculating dividend ratios. The dividend ratio is the percentage of earnings paid to shareholders via dividends. The amount not paid to shareholders is retained by the company to pay off debt or to reinvest in its core operations and would be recorded to a holding, other asset account, then distributed for either the asset or liability. The dividend payout ratio is sometimes simply referred to as earnings per share (EPS), or equivalently, the dividend payout ratio = dividends divided by net income