Account ‘or paid-In capital and prepare the ,equity section of Ii corporate balance sheet. . Stockholders’ equity of a corporation is normally increased in-one of two.ways: (I) from. . contributions by investors in exchange for capital stock=-called paid-In capital or contributed capital, and (2) from the retention of profits earned by the corporation over . tirne=-called retained’ earnings.
As previously noted, our focus in this chapter is primarily on issues related to paid-in capital.We shift our attention to issues, . concerning retained earnings.
Authorization and Issuance of Capital Stock· The articles of incorporation ossify the number of shares that a corporation has been authorized to by state of incorporation. Issues of capital stock that will be sold to the general public must be approved by the federal Securities and Exchange Commission, as well as by state officials.
Corporations nominally obtain authorization for more shares than they initially plan to issue. This way, if note capital is needed later, the corporation already has the authorization to issue additional shires.Shares that have been issued and are in the hands of stockholders are called the outstanding.
At any time, these outstanding shares represent 100% of the stockholders’ equity in the corporation.When a large amount of stock is to be issued, most corporations use the services of an investment banking firm, frequently referred to as an underwriter.
The underwriter guarantees the issuing corporation a specific price for the stock and makes a profit by selling the shares to the investing public at a slightly higher price. The corporation records ,t.he issuance of the stock at the net amount received fro. m the underwriter. The use Of an underwriter assures the corporation that the entire stock issue will be sold without delay and that the entire amount of funds to be raised will be available on a specific date.
The price-that a corporation will seek for a new kissoff stock is based on such factors as:
(1) expected future earnings and dividends,
(2) the financial strength of the company, and
(3) the current state of the investment markets.
If the corporation asks for too much however it simply will not find an underwriter or other buyers willing to purchase the shares. State Laws Affect the Valencia Sheet Presentation.of Stockholder The number of ledger accounts that a corporation must use in the stockholders’ equity section of its balance sheet is determined largely by state laws.
We have seen that corporations use separate stockholders’ equity accounts to represent
(1)contributed capital, or paid-in capital and
(2) carried capital, or retained earnings.
Up to this point we have assumed that all Plaid-in capital is presented in a single account entitled Capital Stoc But this often is not the case. Some corporations issue several different types (or classes) of capital stock. In these situations, a separate account is used to indicate each type of stock outstanding.
A legal concept called par value also affects the balance sheet presentation of paid-in capital. Par Value Par value (or stated value) represents the legal capitalist per share-e-the amount below which stockholders’ equity cannot be.reduced, except by losses from business operations (or by special legal action). The directors cannot declare a divider that would cause total stockholders’ equity to fall below the par value of the outstanding shares.
Par value, therefore, may be regarded as a minimum cushion of equity capital .existing for protectionist creditors. Because of the legal restrictions associate’s par value, state laws require corporations to show separately in the stockholders’ equity section of the balance sheet the par value of shares issued.
The special balance .sheet presentation has fed some people . to believe that par value has some. special significance. most corporations, the par value of the shares issued i’s such a small portion of total stockholders’ equity that it is insignificant.A corporation may set the par value of its stock at $1 per share, $5 per share, or any other amount that it chooses. Most [arge corporations set the par value of their common stocks at nominal amounts, such as 1 cent per share or $1 per share. The par value of the stock ‘is no indication of its market value; the par value. merely indicates the amount per share to be entered in the Capital Stock account.
The stocks of Ford and AT&T have par values of $1; Compaq Computer’s stock has a par value of I cent Stockholders’ Equity: Paid-in Capital and Microsoft’s stock has a par value of one-tenth of a cent. The market value of each of these securities is far above its par value. Microsoft’s stock, for example, has recently traded at a market value in excess of $100 per share, or more than 100,000 times its par value Issuance of Par Value Stock Mere authorization of a stock issue does not bring an asset into existence, nor does it give the corporation any capital. The obtaining of authorization from estate for a stock issue merely affords a legal opportunity to obtain assets through the sale of stock.
When par value stock is issued, the Capital Stock account is credited with the par value of the shares issued, regardless of whether the issuance price is more or less than par. Assuming that 50,000 shares of $2 par value stock have been authorized and that 10,000 of these authorized shares are issued at a price’ of $2 each, Cash would be desited and Capital Stock would/be credited for $20,()()(). When stock is sold for more than par value, the Capital Stock account is credited with the par value of the shares issued, and a separate account, Additional Paid-in Capital, is credited for the excess ‘pf sailing price over pan If.for example, our 10,000 shares were issued at a price of $10 per share, the entry would be