What Type of Account Is Common Stock?

Common stock represents ownership shares in a corporation. It provides investors with a direct stake in the business’s future performance and decision-making. From an accounting standpoint, common stock is classified as an equity account, reflecting the owners’ residual claim on the company’s assets.

Common Stock as an Equity Account

Common stock is categorized as an equity account because it signifies the owners’ claims on the company’s assets after all liabilities have been satisfied. In the fundamental accounting equation, Assets = Liabilities + Equity, common stock directly contributes to the Equity component. This means that if a company were to liquidate, common stockholders would receive any remaining assets only after creditors and other priority claimants, such as preferred stockholders, have been paid.

Common stock is presented within the Shareholder’s Equity section of a company’s balance sheet. This section shows the capital contributed by shareholders and the accumulated earnings retained by the business. Common stock specifically falls under “contributed capital,” which refers to funds directly invested by shareholders for ownership shares.

Issuing common stock is a primary way companies raise capital without incurring debt. When investors purchase common stock directly from the company, they are essentially contributing capital to the business. This inflow of funds increases the company’s assets (typically cash) and simultaneously increases its equity, maintaining the balance sheet equation. This direct investment by owners distinguishes common stock from other forms of financing like loans or bonds, which create liabilities.

Components of Common Stock

The common stock portion of shareholder’s equity comprises par value and additional paid-in capital. Par value, also known as stated value, is a nominal legal value assigned to each share, often set at a very low amount, such as $0.01 or $0.0001 per share. This value serves as a legal capital threshold, meaning shares generally cannot be sold below this price. However, par value usually bears no relation to the stock’s actual market price.

Additional Paid-in Capital (APIC), also referred to as Paid-in Capital in Excess of Par, represents the amount of money received from shareholders for stock that exceeds its par value. When investors pay more than the nominal par value for shares, the excess amount is credited to the APIC account. This component signifies the premium investors are willing to pay above the legal minimum for their ownership stake.

The sum of the common stock (recorded at par value) and the additional paid-in capital accounts reflects the total cash or assets initially contributed by shareholders for the common shares. This contributed capital is distinct from retained earnings, which also form part of total equity. Retained earnings represent the accumulated profits of the company that have not been distributed to shareholders as dividends, whereas common stock and APIC reflect direct investments by owners.

Recording Common Stock Transactions

When common stock is initially issued, specific accounting entries are made to reflect the transaction. The primary goal is to record the cash received by the company and the corresponding increase in the equity accounts. These entries ensure that the balance sheet remains balanced, showing the increase in assets and the corresponding increase in owners’ equity.

If common stock is issued at its par value, the company debits the Cash account for the total amount received and credits the Common Stock account for the same amount. For example, if 1,000 shares with a $1 par value are issued for $1 per share, Cash is debited for $1,000, and Common Stock is credited for $1,000. This entry directly increases both the company’s cash assets and its common stock equity.

Most common stock is issued for a price above its par value. In such cases, the accounting entry involves three accounts: Cash, Common Stock, and Additional Paid-in Capital. The Cash account is debited for the total proceeds received. The Common Stock account is credited for the total par value of the shares issued, with the difference credited to Additional Paid-in Capital.

For instance, if 1,000 shares with a $1 par value are issued for $10 per share, Cash is debited for $10,000. Common Stock is credited for $1,000 (1,000 shares x $1 par), and Additional Paid-in Capital is credited for $9,000 (the $10,000 received minus the $1,000 par value). This ensures the total value recorded in equity matches the total cash received, accurately reflecting the capital contributed by shareholders.