Capital Stock

Key takeaways

• Capital stock is the total number of shares a company is authorized to issue, encompassing both common and preferred shares.
• It appears in shareholders’ equity on the balance sheet and represents the maximum shares that can ever be outstanding.
• Issuing stock raises capital without debt but dilutes ownership and can reduce control for existing shareholders.

Definition

Capital stock is the total number of shares a company is authorized to issue under its charter. This includes all classes of stock (most commonly common and preferred). The company’s balance sheet records the par value portion of issued shares in shareholders’ equity.

How capital stock works

• Authorized shares: the maximum number of shares the company may issue (set in the corporate charter).
• Issued shares: the portion of authorized shares that the company has actually sold.
• Outstanding shares: issued shares that remain held by outside investors (issued minus treasury shares).
• Unissued shares: authorized but not yet issued.
• Treasury shares: previously issued shares that the company has repurchased; they do not carry voting rights or dividends while held by the company.

When a company issues shares, investors pay a purchase price that is usually above the par value. The par-value portion is recorded as capital stock; the excess is recorded as additional paid-in capital (or paid-in capital in excess of par).

Common vs. preferred vs. treasury stock

• Common stock: represents residual ownership, typically includes voting rights and potential dividends. Par value is usually nominal and unrelated to market price.
• Preferred stock: has dividend and liquidation preference over common stock; may have a different par value and dividend terms.
• Treasury stock: shares repurchased by the company; not considered outstanding and do not receive dividends or votes while held in treasury.

Formula and accounting

Capital stock (as reported on the balance sheet) is typically calculated by:
CS = Number of shares issued × Par value per share

Note: different classes of stock may have different par values, so total capital stock is the sum across classes. The market price of shares does not affect the par-value-based capital stock entry; any excess received over par is recorded as additional paid-in capital.

Example:
If a company is authorized to issue 5,000,000 shares with a $1 par value and issues all shares at $10 each:
* Capital stock (par value) recorded = 5,000,000 × $1 = $5,000,000
* Additional paid-in capital = 5,000,000 × ($10 − $1) = $45,000,000

Valuation considerations

Capital stock on the balance sheet is driven by par value and additional paid-in capital, not market capitalization. Events that change the composition or value of capital stock include:
* Initial public offerings (IPO) and secondary offerings — raise paid-in capital and additional paid-in capital.
Share buybacks — reduce outstanding shares and may increase treasury stock.
Stock splits and reverse splits — change share counts and par values per share (accounting entries adjust accordingly).

Advantages and disadvantages

Pros:
* Raises capital without incurring debt or fixed interest payments.
* Flexibility to issue shares over time up to the authorized amount.

Cons:
* Dilutes existing shareholders’ ownership and earnings per share.
May reduce founders’ or managers’ control if voting shares are widely sold.
Triggers regulatory disclosures and reporting obligations.

Frequently asked questions

Q: How long should you hold stock for long-term capital gains tax?
A: Holding an asset for more than one year typically qualifies gains for the long-term capital gains tax rate, which is generally lower than ordinary income tax rates.

Q: How can investors reduce capital gains tax?
A: Common strategies include holding investments for more than one year, harvesting losses to offset gains, and using tax-advantaged accounts.

Q: What does capital stock mean in accounting?
A: In accounting, capital stock is the par-value portion of shares issued to investors, calculated as par value per share times number of shares issued and recorded within shareholders’ equity.

Bottom line

Capital stock defines the maximum shares a company may issue and serves as the basis for equity financing. While issuing stock is an effective way to raise funds without adding debt, it comes with trade-offs: dilution of ownership and potential loss of control, balanced against the absence of fixed repayment obligations.