What Is Common Stock on a Balance Sheet?
Learn how common stock is recorded on a balance sheet, differentiating its accounting value from market price and its role in equity.
Common stock represents a fundamental ownership stake in a company. This article explains how common stock is represented on a company’s balance sheet, aiding in assessing a company’s financial structure and the owners’ claim on assets.
Understanding Common Stock
Common stock is a security that signifies ownership in a corporation. Holders possess rights, including the ability to vote on corporate matters such as electing the board of directors.
Common stockholders also hold a residual claim on the company’s assets and earnings. In the event of liquidation, they are paid only after bondholders, other creditors, and preferred stockholders have received their due. Companies issue common stock to raise capital for operations, expansion, or other corporate objectives.
The Balance Sheet: A Snapshot of Financial Health
The balance sheet serves as a financial statement that captures a company’s financial position at a specific point in time. It provides a snapshot of what a company owns, what it owes, and the owners’ residual interest.
The fundamental accounting equation underpins the balance sheet’s structure: Assets = Liabilities + Equity. Assets represent what a company owns, such as cash, property, and equipment. Liabilities are what the company owes to others, including debts and obligations. Equity, also known as shareholder’s equity, represents the owners’ stake in the company.
Common stock is an integral part of the Equity section of the balance sheet. This section details capital contributed by shareholders and accumulated earnings retained by the company.
Common Stock’s Role in Shareholder Equity
Within the shareholder equity section, common stock is presented at its par value, also referred to as stated value. Par value is an arbitrary legal value assigned to each share, which is often a very small amount, such as $0.01 per share. This low par value is common because regulations prevent shares from being sold below their par value.
When shares are issued, the amount received by the company in excess of the par value is recorded separately as Additional Paid-in Capital (APIC). This account reflects the premium investors paid beyond the legal par value. The sum of common stock at par value and additional paid-in capital represents the total amount of cash or other assets a company received directly from issuing its shares to investors.
The shareholder equity section includes other components alongside common stock and APIC. Retained Earnings represent the cumulative net income that a company has accumulated over its operating history and has chosen to reinvest in the business rather than distribute as dividends to shareholders. These earnings belong to the common shareholders and are part of the total equity.
Another component that can affect total equity is Treasury Stock. This refers to shares of its own stock that a company has repurchased from the open market. Treasury stock is presented as a contra-equity account, meaning it reduces the total shareholder equity on the balance sheet. Companies buy back shares to reduce the number of outstanding shares, which can potentially increase earnings per share.
It is important to understand that the value of common stock presented on the balance sheet, which combines par value and additional paid-in capital, does not reflect the current market value of the company’s shares. The balance sheet figure represents the historical book value based on the original issuance. Market value, in contrast, is the price at which shares trade on a stock exchange, which fluctuates constantly based on supply, demand, and investor sentiment. The difference between book value and market value can be substantial, with market value often exceeding book value for growing companies.