In section Double entry bookkeeping I mentioned that when a company issues shares for cash, that the T-account ‘paid-in capital’ is used to record the shares issued.
No-Par Value Stock Example
The firm issues 1,000 shares for 50 cash each.
The journal entry:
This approach is generally not followed when the shares that have been issued have a par value. The par value, also called the legal value, is a number that is printed on the shares. Some countries require a minimum of legal capital that needs to be issued in order for the firm to be incorporated. In that case, the firm cannot buy back shares or pay out a dividend if doing so would results capital to be below the required minimum legal capital. This gives some protection to creditors. The firm cannot sell the shares to investors below the par value.
Whether or not the firm has to state a par value, and the consequences of putting a low or high number is beyond the scope of these tutorials. If the firm has put a par value, the shares are called par shares. If not, the shares are no par shares. Accounting for no par shares is not covered in these tutorials.
For par value shares, paid-in capital (the issue price) is separated into par value and additional paid-in capital (or, share premium), which is the difference between the issue price and the par value.
Par Value Stock Example
The firm issues 1,000 shares for 50 cash each. Shares have a par value of 1.
The journal entry:
|Additional paid-in capital||49,000|
Preference shares (discussed later) are often issued at the par value. The issue price of regular, or common, shares is often not related to the par-value.
Par Value Stock Sale Example
In its their initial public offering (IPO) in 2004, Google issued shares for $85 per share, whereas the equity section of their 2008 balance sheet shows that the par value of these shares is only $0.001 per share.
Since 2004, Google has collected about $14.5 billion by issuing shares. The legal capital of these shares is only $315,000.
Par Value Stock Explained
– many countries require that corporations have a minimum of capital, which serves as a buffer to protect creditors
– the capital requirements are met by raising equity capital by issuing shares such that the number of shares issued multiplied by the chosen par value (legal value) exceeds the required minimum amount
– firms cannot issue shares below the par value
– for par shares, the par value is recorded on the T-account common shares and the difference between the issue price and the par value on additional paid-in capital (or, share premium)