What is a Discount on Stock?

//What is a Discount on Stock?
What is a Discount on Stock? 2017-10-03T05:11:08+00:00

Definition: A discount on stock occurs when the stock’s par value is higher than the issuing price. The difference between the greater par value and the lesser issue price is considered the discount. This represents the amount of the par value that investors were unwilling to pay for when the stock was issued.

What Does Discount on Stock Mean?

Many states have laws that prohibit corporations from issuing stock at a discount in order to protect creditors. A thinly capitalized company can put creditors at risk because there might not be enough assets to cover the debts owed to creditors in the event of a default. In many cases, shareholders who purchase shares below the par value become contingently liable to creditors for the amount of the discount.

Accounting for shares issued at a discount is quite simple. The discount on common stock account is used to record the discount. This account is a contra equity account that reduces the common stock par value on the balance sheet. Notice that this is a balance sheet account—not an income statement account. The discount is not recorded as an expense and is not presented on the income statement.

Let’s take a look at an example.

Example

Beth’s Bracelet Company is seeking out new investors and trying to sell its $10 par value stock. Unfortunately, there isn’t much interest in the company and Beth could only find one investor who is willing to purchase 1,000 shares for $5 per share. Beth agrees to the price and issues 1,000 new shares to the investor.

She records the new stock issuances by debiting cash for $5,000, debiting discount on common stock for $5,000, and crediting common stock for $10,000. Notice that the common stock account is credited for the full par value per share. The contra account contains the corresponding debit to reduce the par value to the actual amount paid at issuance.