Stockholders' Equity - Classes of Capital Stock

Summary :

This chapter states the advantages and disadvantages of the corporate form of business and lists the values commonly associated with capital stock. It covers the various kinds of stock and how they differ, presenting the stockholders' equity section of a balance sheet, and accounting for stock issued for cash and other assets.

The corporate form and stock values

Organizing as a corporation offers advantages such as limited liability for owners, ease of transferring ownership through shares, and continuity of life beyond any one owner, but it also carries disadvantages, including double taxation of corporate income and greater regulation than other business forms. Capital stock carries several distinct values, including par or stated value, the amount printed on the certificate, and market value, the price at which shares actually trade, and these values do not necessarily move together.

Classes of stock and issuing shares

Common stock represents the basic ownership class and normally carries voting rights, while preferred stock typically gives up voting rights in exchange for preferences, such as a stated dividend rate paid before common shareholders receive anything and, often, priority in liquidation. Stock is recorded at the fair value of what is received when issued for cash, and at the fair value of the stock or of the assets received, whichever is more clearly determinable, when issued for noncash assets.

Presenting equity and measuring book value

The stockholders' equity section of the balance sheet presents paid-in capital, broken out by class of stock and any amounts received above par, together with retained earnings, so a reader can see both what owners contributed directly and what the company has earned and kept. Book value per share, computed separately for preferred and common stock, and return on average common stockholders' equity, which relates net income available to common shareholders to their average equity investment, are used to evaluate a corporation's performance for its owners.