Companies can raise finance by offering their shares to the public, employees, and even other corporations. Likewise, shares can be issued to selective investors by private placement. This article shall discuss details regarding the subscription of shares and related accounting treatment for issuing shares.
What is the subscription of shares?
The subscription of shares is a contract that allows investors to buy the shares of a company at a specific price. In other words, a subscription of shares is a legal agreement between the investors and a company that enables investors to acquire certain ownership. The shares can be of different types, including ordinary, preference, treasury, etc.
The word subscription is used when the company and cash directly issue shares are deposited in the company’s bank account. It’s different from the normal purchase and sale of the shares between the seller and vendors.
Sometimes, management and employees can subscribe to the shares under-compensation or based on the performance. The subscription options help create a win-win situation for the management and company. For instance, if managers are given ownership in the company, they are expected to achieve organizational goals. This leads to an appreciation of share value for both employees and shareholders.
Further, a subscription of shares is beneficial for a company because it generates a continuous stream of cash inflows when employees purchase shares constantly. Likewise, it’s an effective tool to retain management and employees for the long term.
Accounting for the subscription of shares
The stock subscription records are maintained by businesses to identify shareholders and the respective amount received from them. To record the accounting entries for the stock subscription, accounts receivable are created against future receipt of the funds. On the other hand, a stock subscription account is credited. However, a journal entry is made to convert accounts receivable assets into cash when the company finally receives cash.
Full and Partial subscription of shares
Generally, shares are paid in full. However, sometimes investors may be allowed to subscribe to shares and defer partial payment, such a situation is called a partial issue of the shares. So, if the payments against the purchase of stock are made in installments, the company must record the proceeds from the stock sale as and when received. It means when cash is received, the cash account should be debited against a credit of stock subscription receivable account.
Examples of subscription of shares (fully issued shares)
Suppose TPL ltd. is issuing 75,000 shares at a par value of $1 common shares. Let’s do accounting for the same.
The following journal entry will be posted in the accounting record when the company agrees with some party to subscribe to the shares.
| Particulars | Debit$ | Credit$ |
| Stock subscription Receivable account | 75,000 | |
| Common stock subscribed account | 75,000 |
The debit impact of the transaction is recorded for the receivable under the issuance of shares. Since the company is issuing shares at PAR value, the cash to be received will be recorded against the common shares subscribed account, which is the credit impact of the transaction.
Later on, when TPL ltd receives cash against this transaction, the following entry will be recorded.
| Particulars | Debit$ | Credit$ |
| Cash | 75,000 | |
| Stock subscription Receivable account | 75,000 |
The debit impact of the transaction is receipt of the cash in the business bank account. Likewise, the credit impact of the transaction is the removal of the receivables that were created at the time of issuing equity.
Examples of subscription of shares (partial issued shares with additional paid-in capital)
Suppose TPL ltd. issues 5,000 new preferred shares at a par value of $20. The current market price of the shares amounts to $30. An investment company has come forward to subscribe to these shares and agreed with the company to pay the amount in two installments. The company agreed on the terms due to some business incentives.
Since the investor is making two installments, we will record half of the amount as cash received, and half will remain in the subscription receivable account.
It’s equally important to note that the amount received in excess of the PAR value (Nominal value) is recorded as additional paid-in capital. So, let’s calculate additional paid-in capital.
Calculation of additional paid-in capital
The calculation of Additional paid in capital is described below:
= (Number of shares * market price) – (Number of shares * par value of shares)
= (5,000 shares * $30) – (5,000 shares * $20)
= ($150,000 – $100,000)
= $50,000
Overall, in this example, we need to record shares subscriptions (partial issue) in an installment when the share price is more than the PAR value. The following journal entry will be posted in the accounting record.
| Particulars | Debit$ | Credit$ |
| Cash | 75,000 | |
| Stock subscription receivable | 75,000 | |
| Preferred stock subscribed | 100,000 | |
| Additional paid-in capital | 50,000 |
The impact of the first debit is receipt of the first installment amount. It’s the cash received and recorded in the books. The second debit is about creating the right to receive the remaining amount.
The impact of first credit is the recording of the capital in the preferred stock account. The $100,000 is recorded as the number of shares is 5,000, and the PAR value is $20 per share. So, it totals $100,000 (5,000*20=$100,000).
The value for the second credit is obtained from the calculation performed in the previous step. It’s recorded as additional paid-in capital as this amount is in excess of the preferred stock.
Following entry is posted in the accounting record when the remaining cash is received.
| Particulars | Debit$ | Credit$ |
| Cash | 75,000 | |
| Stock subscription receivable | 75,000 |
The debit impact is receipt of the cash, and credit impact is the removal of the right to receive the cash from the subscriber.
So, it completes the cycle for the subscription of the shares.
Conclusion
The company can opt to raise the finance via the issuance of the shares. These shares may be of different types like common shares, preferred shares, and treasury shares, etc. Generally, companies issue shares on PAR value (nominal value) and record an issue of the capital in the main capital account. However, if the amount received is above PAR value, an excess is recorded as additional paid-in capital.
The company can issue shares to other companies, the public, and individuals against receiving cash from subscribers. It’s equally important to note that the word subscriptions is used when the company directly issues shares.
Further, there can be full share issues and partial share issues. For instance, if the cash is received at once, it’s said to be a full issue. On the other hand, if the cash is received in installments, it’s said to be a partial issue.
Frequently asked questions
What’s the difference between common capital and additional paid-in capital?
The capital received to the extent of PAR value is said to be common capital. On the contrary, if the company receives capital in excess of the PAR values, it’s called an additional paid-in capital. For instance, if the company issues 100 shares (PAR value $5) for $12, the capital obtained to the extent of PAR $500 (100*5) is called common capital. An additional $7 per share of $100 ($7*100) is said to be additional paid-in capital.
Why are shares issued to the employees and management of the company?
Shares are issued to the employees to increase their alignment with the company. It gives them a true sense of ownership, enhancing their efforts to achieve long-term goals. Hence, it’s a win-win situation for both company and management/employees.
What is paid-in capital?
Paid in capital is the total amount of the cash received from the investor. It includes both common stock and additional paid-in capital. For instance, if the company issues 100 shares (PAR value amounting to $5) at a price of $7. Total capital obtained amounting to $700 ($7×100) is paid-in capital.
How retained earnings impact the business capital?
Retained earnings are part of total business capital. So, if there is a change in the equity, it leads to changes in the total equity/capital. Further, a change in the retained earnings is brought by profit/loss for the business.