The firm can issue (additional) capital by issuing shares. Shareholders own the firm; they bear the most risk, and have the highest (potential) rewards. Investors usually pay cash to become a shareholder, but in principle, it is possible they pay for the shares in other ways. For example, by transferring ownership of a building, providing services, or converting a bond.

When shares have special rights, they are called preferred shares, as opposed to ‘common’ shares. Shares that are listed on exchanges are (with some exceptions) common shares. Usually, ‘shares’ and ‘common shares’ are used interchangeably. The special rights of preferred shares can (for example) be related to hiring/firing the firm’s management (to frustrate hostile takeovers), having a preferred claim in case of liquidation, or receiving a (predetermined) dividend before the common shareholders do. I include a section on dividend-preferred shares.

For a corporation, the articles of incorporation will include the possibility for management to issue shares. The maximum number of shares a firm can issue is called authorized shares. The shares that have actually been sold to investors are called issued shares. Not all issued shares are held by investors, it could be the firm has purchased some of their shares back from the investing public. These shares are called treasury shares. The difference (issued shares minus treasury shares) is outstanding shares.

Par and no par shares

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.


The firm issues 1,000 shares for 50 cash each.

The journal entry:

T-account Debit Credit  
Cash 50,000    
Paid-in capital   50,000  

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.


The firm issues 1,000 shares for 50 cash each. Shares have a par value of 1.

The journal entry:

T-account Debit Credit  
Cash 50,000    
Common shares   1,000  
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.


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 (see here and here).

Since 2004, Google has collected about $14.5 billion by issuing shares. The legal capital of these shares is only $315,000.

Key points:
- 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)

Treasury shares

Treasury shares are shares that have been issued, but which the firm has repurchased from investors. Thus, treasury shares are no longer outstanding (but are still issued). Treasury shares can be resold to investors (and be outstanding again), or they can be cancelled (in that case they are no longer issued).

Economically, treasury stock is an asset. Also, a firm can make money with trading in their own stock. In order to mitigate the incentive for management to increase profits with trading in their own shares, accounting regulation requires that the asset treasury shares be deducted from equity, and that gains and losses on trading in treasury shares are not included in net income, but instead are booked straight into equity. This is an exception to the rule that all revenues and expenses are recorded on temporary T-accounts.

Gains are added to a T-account called ‘additional paid in capital, treasury shares’. Losses are subtracted from previous gains. To the extent that cumulative losses exceed cumulative gains, losses are subtracted from retained earnings.


The firm buys 1,000 of its own shares for 50 each. The firm had not previously purchased treasury shares.

The journal entry:

T-account Debit Credit  
Treasury shares 50,000    
Cash   50,000  

The firm sells 400 treasury shares for 52 each:

T-account Debit Credit  
Cash 20,800    
Treasury shares   20,000  
Additional paid-in capital, treasury shares   800  

The firm sells the remaining 600 treasury shares for 47 each:

T-account Debit Credit  
Cash 28,200    
Additional paid in capital, treasury shares 800    
Retained earnings 1,000    
Treasury shares   30,000  

On the sale of the 600 shares a loss is made of 1,800 (=600 x (50-47)). Previous cumulative gains (and losses) on ‘additional paid in capital, share premium’ amount to 800, which is reduced to zero and the remaining loss of 1,000 is subtracted from retained earnings.   

Key points:
- treasury shares are shares that the company has repurchased, but not cancelled; these
- treasury shares are issued, but not outstanding
- treasury shares is deducted from equity
- gains/losses on treasury shares are not included in net income, but added/subtracted from equity
- gains are added to ‘additional paid-in capital, share premium’; losses are subtracted from this T-account (if it has a positive balance), or otherwise subtracted from retained earnings

Cash dividend

When it is assumed that the firm pays a dividend on the same day it had decided to do so, accounting is straightforward. Cash is reduced, and a temporary T-accounts ‘dividends declared’ is used to record the decrease in retained earnings. At the end of the period, when the period is closed, dividends declared is subtracted from retained earnings.


The firm declares a 0.10 dividend per share. There are 200,000 shares issued and outstanding.

The journal entry:

T-account Debit Credit  
Dividend declared 20,000    
Cash   20,000  

However, normally there will be time between the decision to pay a dividend (the declaration) and the actual payment. This requires the need to identify which person will receive the dividend, as with stock listed companies ownership changes continuously. Three dates are relevant: (1) the declaration date, (2) the date of record and (3) the payment date.

On the declaration date, management decides to pay a certain dividend. The dividend is either expressed as an amount for each share, or as a percentage of the par value of the share. Investors that owned the share on the date of record will receive the dividend on the payment date. On the day following the date of record the share goes ‘ex-dividend’, meaning that if you will buy the share on (or after) that day, you will not receive the dividend.

A liability T-account ‘Dividend payable’ is used to bridge the time between promising the dividend on the declaration date and the actual payment.


The firm has issued 100,000 shares with a par value of 5 each, of these shares, 10,000 have been repurchased as treasury shares. On December 15th, management declares of 10% dividend, payable on February 1st to shareholders on record on January 15th.

The journal entry for the declaration on December 15th:

T-account Debit Credit  
Dividend declared 45,000*    
Dividend payable   45,000  

*4,500 = 90,000 shares outstanding x 5 par value x 10% dividend

No journal entry is needed for the date of record.

The journal entry for the payment date (February 1st):

T-account Debit Credit  
Dividend payable 45,000    
Cash   45,000  

Key points:
- declarations of dividend are recorded on a temporary T-account ‘dividends declared’, which at year’s end is subtracted from retained earnings
- the declaration date is the date on which management decides to pay out a dividend, at this time a liability ‘dividends payable’ is recorded
- the date of record is the date which is used to whom the dividend is paid; the next day the shares go ‘ex-dividend’
- on the payment date the liability ‘dividends payable’ is paid

Share dividend

A share dividend is a dividend in the form of extra shares. From the point of the investor, no ‘real’ dividend is received. Extra shares are issued that are given to existing shareholders. Thus, the value of the firm is spread out over an increased number of shares, thus decreasing the value per share.

From the viewpoint of the firm, however, retained earnings, which is a reserve, is turned into paid-in capital by an amount of the market price at the declaration day multiplied by the number of shares to be issued. Similar to the cash dividend, the declaration date, date of record and the issue date are relevant.

An equity T-account ‘common shares distributable’ is used between the declaration date and the actual issue to show that the firm has committed itself to issuing shares.


The firm has issued 100,000 shares with a par value of 5 each, of these shares, 10,000 have been repurchased as treasury shares. On March 10th, the firm declares a 5% share dividend to be distributed on April 20th to the shareholders on record on March 24th. The firm’s stock price on March 10th is 10.

Journal entry on the declaration date:

T-account Debit Credit  
Share dividend 45,000*    
Common shares distributable   11,250  
Additional paid-in capital   33,750  

* 90,000 shares x 5% share dividend x $10 value per share

Key points:
- a share dividend is a dividend in the form of shares; existing shareholders receive additional shares
- at the date of declaration, this dividend is recorded on a temporary T-account ‘dividends declared’ which is subtracted from retained earnings at year’s end
- ‘common shares distributable’ is an equity T-account which indicates that new shares have been declared, but not yet issued

Share split

As the name suggests, with a share split the firm can reduce the share price by increasing the number of shares outstanding. For example, a 3 for 2 share split means that for every 2 shares an investor owns, a third share is issued for free. With a share split, the firm aims to keep the stock price within a trading range that provides the most liquidity.

No journal entry is needed, as the number of shares increases by some factor, all per-share based figures decrease proportionally.


Not all firms split their shares. At the time of this writing (January, 2010), Google’s share price was $620 per share. Even though most investors are able to pay a single share, it will prevent (some) shareholders to buy Google shares if (for example) they want to buy a put option to limit their risk. One option contract relates to 100 underlying shares.

The ask-price of a January 2012 put option with a strike of $620 was $90,70 (giving the option holder the right (and not the obligation) to sell 100 shares for $620 until January 2012). As 1 put option relates to 100 underlying shares, the ask price for one contract is $9070. Thus, an investor who wants to reduce downside risk will needs to own 100 shares worth $62,000 such that the option contract matches the number of shares. In this case, for example a 10-1 share split would reduce the required sum by a factor 10.

A reverse split can be used in the situation where a share is trading at a (very) low price range (for example a penny stock).

Key points:
- with a share split, the number of shares increase by some factor, while at the same time the par value per share decreases by the same factor, leaving the value of common shares unchanged (no journal entry is necessary)
- share splits are performed so that the share price is in a ‘normal’ trading range
- a reverse split is used when the share price is very low

Dividend preferred shares

Shares can have special rights, or other attributes that the ‘regular’ shares (common shares) do not have. If so, these shares are preferred shares. Here I will only consider preferred shares that receive dividend before the common shareholders do.

Preferred (dividend) shares legally qualify as equity, but economically have more common with a loan. Preferred shareholders receive a fixed dividend if earnings permits. The amount of net income in excess of preferred dividend can be used to pay a dividend to the common shareholders.

The preferred dividend can be either non-cumulative, or cumulative. In case the shares are non-cumulative, the claim on the dividend is not carried forward to the next year to the extent that earnings fall short to pay out the preferred dividend. When the shares are cumulative preferred shares, any unpaid dividend is carried forward to the next period. The carried forward dividends are called ‘dividend in arrears’.

Key points:
- holders of preferred (dividend) shares have priority over common shareholders to receive a dividend
- if there is no profit, then also the preferred shareholders receive no dividend
- the preference can be cumulative, in which case unpaid dividend (‘in arrears’) is carried forward, or noncumulative

Continue with reading the next tutorial: Cash flow statement

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