Principles of Financial Accounting: Stockholders' Equity - Classes of Stock, Preferred vs. Common Stock Features

What It Is

Classes of stock refer to the different types of shares issued by a company to raise capital. There are two primary classes: Preferred Stock and Common Stock. Preferred stock has a higher claim on assets and dividends than common stock, but common stockholders have more voting rights. Understanding the features of each class is crucial in financial accounting, as it affects a company's financial statements and shareholder equity. For example, if a company issues $100,000 of preferred stock with a 5% dividend, it will increase shareholder equity and create a liability for the dividend payment.

Key Concepts & Formulas

• Par Value: The minimum price at which a share of stock can be issued. Example: A company issues 1,000 shares of common stock with a par value of $10 per share.
• Stated Value: The value assigned to a share of preferred stock. Example: A company issues 1,000 shares of preferred stock with a stated value of $50 per share.
• Dividend Rate: The percentage of dividend paid on preferred stock. Example: A company issues 1,000 shares of preferred stock with a 5% dividend rate.
• Authorized Stock: The maximum number of shares a company is authorized to issue. Example: A company has 1,000,000 authorized shares of common stock.
• Issued Stock: The number of shares actually issued to shareholders. Example: A company issues 500,000 shares of common stock.
• Outstanding Stock: The number of shares held by shareholders. Example: A company has 400,000 shares of common stock outstanding.
• Book Value: The value of a share of stock on the balance sheet. Example: A company has a book value of $50 per share for its common stock.
• Market Value: The current price of a share of stock. Example: A company's common stock is trading at $75 per share.

Journal Entry Examples

1. Issuance of Common Stock

Dr. Cash $50,000 Cr. Common Stock $50,000 Cr. Additional Paid-in Capital $50,000

Explanation: The company receives cash from shareholders and records the issuance of common stock, increasing shareholder equity.

1. Issuance of Preferred Stock

Dr. Cash $100,000 Cr. Preferred Stock $100,000 Cr. Additional Paid-in Capital $100,000

Explanation: The company receives cash from shareholders and records the issuance of preferred stock, increasing shareholder equity.

Common Mistakes

• Mistake: Confusing authorized stock with issued stock.
• Correction: Authorized stock is the maximum number of shares a company can issue, while issued stock is the number of shares actually issued to shareholders. Mnemonic: "Authorized is like a limit, Issued is like the actual sale."
• Mistake: Not distinguishing between par value and stated value.
• Correction: Par value is the minimum price at which a share of stock can be issued, while stated value is the value assigned to a share of preferred stock. Mnemonic: "Par is like a minimum, Stated is like a value assigned."
• Mistake: Not understanding the difference between dividend rate and dividend payment.
• Correction: Dividend rate is the percentage of dividend paid on preferred stock, while dividend payment is the actual amount paid to shareholders. Mnemonic: "Rate is like a percentage, Payment is like the actual cash."

Exam Tips

• Tip: When dealing with stock transactions, remember that cash is always debited or credited, while stock is always credited.
• Tip: Be careful with reversing normal balances, as it can lead to incorrect journal entries.
• Tip: When calculating book value, remember to subtract any treasury stock from the total number of shares outstanding.

Quick Practice

1. A company issues 1,000 shares of common stock at $50 per share. What is the journal entry for the issuance of common stock?

Dr. Cash $50,000 Cr. Common Stock $50,000 Cr. Additional Paid-in Capital $50,000

Explanation: The company receives cash from shareholders and records the issuance of common stock, increasing shareholder equity.

1. A company has 1,000 shares of preferred stock outstanding with a par value of $100 per share. What is the total par value of the preferred stock?

$100,000

Explanation: The total par value is calculated by multiplying the number of shares outstanding by the par value per share.

Last-Minute Cram Sheet

1. Dividends are NOT an expense – they go directly to retained earnings.
2. Preferred stock has a higher claim on assets and dividends than common stock.
3. Common stockholders have more voting rights than preferred stockholders.
4. Par value is the minimum price at which a share of stock can be issued.
5. Stated value is the value assigned to a share of preferred stock.
6. Dividend rate is the percentage of dividend paid on preferred stock.
7. Authorized stock is the maximum number of shares a company can issue.
8. Issued stock is the number of shares actually issued to shareholders.
9. Outstanding stock is the number of shares held by shareholders.
10. Book value is the value of a share of stock on the balance sheet.