Capital stock refers to both common and preferred stock. Only corporations have the ability to sell capital stock to investors. Selling capital stock is one of the ways a company can raise funds to operate and expand the business. Investors purchase shares of a company with the goal of receiving favorable dividend payments from the business.
Raising capital is one of the primary reasons a company issues shares to investors. Also, a company has the ability to issue shares in exchange for assets like buildings, land, patents and equipment. The capital shares an investor purchases represents his ownership interest in the business. For instance, assume a corporation issues 50,000 shares, 25,000 of which are bought by one investor. In this scenario, the investor owns 50 percent of the business. A company’s accounting records are only affected when the company issues, sells or purchases its own shares. This means the company’s accounting records are not affected when shares are bought and sold on the stock market.
The number of shares a corporation has the authorization to sell appears in the company’s articles of incorporation. The articles of incorporation is the charter document that provides information such as the company’s date and location of incorporation, the name of the business, and the purpose for creating the company. The number of shares a company issues represents the number of shares sold to investors. A company does not have to issue all of its authorized shares. This allows the company to use the remaining authorized shares as a way to raise capital at a later time.
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One of the biggest advantages of selling capital stock is that the company avoids using debt to finance its operations. When a company uses a loan to raise capital, the company will have to pay the principal amount of the loan plus interest. There is no interest involved when selling capital stock. Also, the cash raised as a result of the stock issuance does not get repaid to investors. Furthermore, selling capital stock provides a company with the ability to raise more money than it might be able to borrow from a lender.
Journalizing Capital Stock
A company is required to record the sale of capital stock in the general journal. The date when the company sells the shares must appear in the general journal. The company must debit an asset account to illustrate the amount of cash received, or the value of the asset received. For instance, a company that sells 20,000 share of capital stock for $100,000 must debit cash for $100,000. This indicates a $100,000 increase in the company’s cash account. The company must credit preferred or common stock for $100,000 to balance the entry. The $100,000 credit to the preferred or common stock account indicates the amount contributed to the business by investors.