Reporting of capital stock

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Reporting of capital stock includes an explanation of changes in the number of capital shares. This information is disclosed in the financial statements or related notes. The following partial list shows reasons for changes in capital stock, separated according to increases and decreases.

Sources of increases in capital stock outstanding:

• Issuances of stock.
• Conversion of debentures and preferred stock.
• Issuances pursuant to stock dividends and splits.
• Issuances of stock in acquisitions and mergers.
• Issuances pursuant to stock options and warrants exercised.

Sources of decreases in capital stock outstanding:

• Purchases and retirements of stock.
• Stock buybacks.
• Reverse stock splits.

Another important aspect of our analysis of capital stock is the evaluation of the options held by others that, when exercised, cause the number of shares outstanding to increase and thus dilute ownership. These options include:

• Conversion rights of debentures and preferred stock into common.
• Warrants entitling holders to exchange them for stock under specified conditions.
• Stock options with compensation and bonus plans calling for issuances of capital stock over a period of time at fixed prices examples are qualified stock option plans and employee stock ownership plans.
• Commitments to issue capital stock an example is merger agreements calling for additional consideration contingent on the occurrence of an event such as achieving a specific earnings level.

The importance of analyzing these disclosures is to alert us to the potential increase in the number of shares outstanding. The extent of dilution in earnings and book value per share depends on factors like the amount received or other rights given up when converting securities. We must recognize that dilution is a real cost for a company a cost that is given little formal recognition in financial statements.

Contributed Capital

Contributed (or paid-in) capital is the total financing received from shareholders in return for capital shares. Contributed capital is usually divided into two parts. One part is assigned to the par or stated value of capital shares: common and/or preferred stock (if stock is no-par, then it is assigned the total financing). The remainder is reported as contributed (or paid-in) capital in excess of par or stated value (also called additional paid-in capital ). When combined, these accounts reflect the amounts paid in by shareholders for financing business activities. Other accounts in the contributed capital section of shareholders’ equity arise from charges or credits from a variety of capital transactions, including (1) sale of treasury stock, (2) capital changes arising from business combinations, (3) capital donations, often shown separately as donated capital, (4) stock issuance costs and merger expenses, and (5) capitalization of retained earnings by means of stock dividends.

Treasury Stock

 Treasury stock (or buybacks) are the shares of a company’s stock reacquired after having been previously issued and fully paid for. Acquisition of treasury stock by a company reduces both assets and shareholders’ equity. Consistent with this transaction, treasury stock is not an asset, it is a contra-equity account (negative equity). Treasury stock is typically recorded at cost, and the most common method of presentation is to deduct treasury stock cost from the total of shareholders’ equity. When companies record treasury stock at par, they typically report it as a contra to (reduction of ) its related class of stock.

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