What Does Sub Par Mean?

In financial scenarios, a security trading sub par is one that is currently being priced by the market below its nominal value. For example, a bond that has a face value (the actual amount of money that will be paid by the company when it reaches maturity) of a $1,000 and is currently being valued at $850 is said to be trading sub par, which means, below its actual value.

The reason why this occurs is that the interest rate paid by the bond is less than the rate the market expects for such instrument. This expected rate is frequently calculated by using the risk-free rate of return (which is the interest rate offered by securities graded as AAA) plus a risk premium that depends on the market’s overall risk and the risk of the company or organization issuing the financial instrument.

In other business situations, as is the case of production figures, a company with an installed capacity to produce 5,000 units per day that is currently producing only 2,500 could also be regarded as operating on a sub par basis.

Example

International Paint Co. is a company that manufactures rubber-based paint and has distributors and franchisees all over the world. The company currently has many ongoing expansion projects but it needs financing in order to continue developing them.

They have an outstanding bond issue that is currently being valued at 95% of its face value, due to the fact that the bonds pay an interest rate of 2% and currently the risk-free rate of return is also 2%, but since the company has a bigger risk than these AAA securities, to compensate for such difference, the market is valuing the bonds at a sub par basis. The company now has to evaluate what would be the most advantageous interest rate that they should offer for the new bonds they are about to issue.

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What Does Withdrawal Mean?

When an owner withdraws money from a company for personal use, the company takes this out of his share of capital. This makes sense because the owner is essentially cashing out his share in the company. He is receiving cash in exchange the company is buying back some of his capital.

The company would record a journal entry for an owner withdrawal by debiting owner’s withdrawal and crediting cash. Owner’s withdrawal is a temporary capital or equity account that is closed to the general owner’s capital account at the end of the year.

Example

Let’s assume Mike has a 50% share of Blue Guitar, LLC. He decides that he wants to buy a new car, so he withdraws $10,000 from his share in the partnership. Blue Guitar, LLC would record a debit the Mike’s capital withdrawals account and a credit to cash for $10,000.

After the closing of the year, Mike’s capital account will be $10,000 less because of this withdrawal.

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What Does Treasury Stock Mean?

Treasury stock is similar to unissued shares in that neither is considered an asset of the company. Also, neither treasury nor unissued stock receives dividends or has voting privileges. Since a corporation can’t be its own owner, the only real difference between a treasury share and an unissued share is that one was once issued and the other wasn’t.

You might be wondering why a corporation would ever want to buy its own shares back. What sense does that make? Why did they issue them in the first place? There are several main reasons why the board of directors might consider purchasing some of the outstanding shares from current investors.

Example

The first reason is for compensation purposes. Many executives get paid with stock options or rights to purchase shares in the future. The company might purchase outstanding shares to reissue them as compensation later on.

The second reason is to use the stock in another purchase. Some mergers and buyouts require equity financing and often times the company being merged is paid out with stock instead of cash. If there isn’t enough unissued shares for a buyout, the board might purchase some treasury stock.

The third reason is to protect the business from a hostile take over. If an investor or group of investors is purchasing large amounts of stock with plans to upset the company, the board might move quickly to purchase additional outstanding shares in order to defeat the takeover.

The last main reason for a board to consider purchasing outstanding shares is to maintain a strong market price. Sometimes too many shares can dilute investors’ confidence and the price can fall. By maintaining a smaller quantity of shares outstanding, management may effectively be able to maintain the stock price.

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What Does Stockholder’s Equity Mean?

Stockholder’s equity is made up of two main parts: paid in capital and retained earnings. Paid-in capital is the total amount of money the corporation received from investors for their shares of stock. Paid in capital is often broken down into two different accounts: common stock and paid-in capital in excess of par. The common stock account typically reports the par or stated value of outstanding shares while the PIC in excess of par shows the amount investors were willing to pay for shares over their stated price.

Retained earnings are the profits that the company has accumulated over time. Each year the company makes a profit and doesn’t distribute the cash to the investors, it accumulates in the retained earnings account. You can think of this account like the amount of money investors left in the company after all of the expenses were paid.

Example

Many people refer to the equity section of the balance sheet as the net assets of the company because it represents the amount of assets that are left over after all of the liabilities are repaid. By moving around the accounting equation (assets = liabilities + owner’s equity) we can see that the equity section equals the difference between the assets and liabilities (assets – liabilities = owner’s equity).

Total stockholder’s equity is reported in the equity section of the balance sheet at the end of each period. It is also computed on the statement of shareholder’s equity by using the following equation:

• Beginning balance
• Plus:
  • Net income
  • Issuance of stock
  • Other
• Less:
  • Dividends
• Ending balance

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What Does Stock Split Mean?

Since additional shares are issued, both the par / stated value and the market value are decreased by the multiple of newly issued stock. You can think of this like cutting an apple in half. After the apple is split in half, you have two pieces of apple, but it’s still worth the same amount as one whole apple. You just have two smaller pieces of apple now. A reverse stock split will have the opposite effect. This concept might be easier to understand with an example.

Example

Big Al Corp. has 1,000 $5 par value shares outstanding at the beginning of the year. This is Big Al’s fourth year of high profits and as a result, its market value per share has increased from $10 per share to $500 per share. Fearing that the high stock price will scare off new investors, Big Al decides to do a 1-for-5 stock split to reduce the market value of it’s shares.

The one-for-five split recalls the original shares and replaces each share with 5 shares. Thus, after the split, Big Al Corp. will have 5,000 $1 par shares outstanding. The market price will also be reduced by the split multiple of five resulting in a new market value of $100 per share. There is no journal entry required to record a stock split since no change in equity actually occurred.

So on the owner level, each shareholder would own five times more shares after the split than before the split, but the total value would still be the same. A person who owned one $500 share before the split would now have five $100 shares after the split.

Stock splits typically require approval by both the shareholders and the board of directors and are made for a variety of reasons. The most common reasons include making shares more affordable, getting rid of uneven holding amounts, and establishing an issuance price.

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What Does Stock Dividend Mean?

Corporations typically issue stock distributions to investors for a variety of reasons. Many companies don’t have the cash to pay investors cash dividends, but they still want to encourage shareholders to keep their money invested in the company. Thus, the corporation gives each shareholder additional shares of stock based on their current ownership percentage, instead of cash. This way the shareholders receive a return on their investment and the corporation doesn’t have to part with its cash.

Since no cash is involved in a stock distribution, the assets and equity accounts are not affected by the transaction. The equity account is simply increased by the amount of shares issued to investors and decreased by the amount of the dividend given to each shareholder resulting in net zero effect.

Example

These dividends follow the same timeline as a standard cash dividend: date of declaration, record, and payment. First, the board of directors declares that they will issue a payment to shareholders. Second, a record is created of the stockholders on that date. Third, new shares are issued to the previously recorded shareholders.

Unlike cash distributions, share dividends are reported two different ways depending on the number of shares being issued. A small stock dividend is a distribution of 25 percent or less of the previously outstanding shares and is accounted for by capitalizing the fair market value of the newly issued shares. A large stock dividend is a distribution of more than 25 percent of the outstanding shares and is accounting for by capitalizing the minimum legal value of the newly issued shares. This could either be the par value or stated value per share.

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What Does Stock Certificate Mean?

What is the definition of stock certificate? Historically, investors received share certificates as a proof of ownership of their shares. Stock certificates contained information related to the number of shares, the date of issuance, an identification number, and other important information.

To avoid replication, certificates usually feature intricate design, which might change over the course of years, a corporate seal, and several signatures. Often, certificates serve as evidence of entitlement to dividend payments with a receipt of payment attached on their back. However, in modern times, stock ownership is usually recorded electronically with a depositary securities system.

Let’s look at an example.

Example

Jonathan is a 75-years old investor. He has a brokerage account with a boutique brokerage firm, and he trades several stocks each month. Jonathan is a sophisticated investor, and he can follow the market trends. The only thing he cannot get used to is the electronic record of ownership.

Jonathan prefers to hold a physical stock documentation, a piece of paper with his name on, the number of shares he owns to each company, and all necessary information to prove stock ownership. Each month, he goes to his broker and requests a certificate, which the broker gets from the issuing corporation on Jonathan’s behalf.

The only problem that Jonathan faces is that some of the companies he has invested in are not interested in issuing a certificate, although they are obliged by the law to do so because it requires more administrative work. So, in some cases, Jonathan has to put up a fight with the company to get his stock documentation. From the company’s perspective, the companies are recording all the stockholders who are requesting stock certificates.

Summary Definition

Define Stock Certificates: Stock certificate means the document that represents an ownership stake in a corporation.

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What Does Stock Mean?

What is the definition of stock? The shared capital of each company consists of a certain number of shares with a nominal value. A shareholder can fully participate in the company’s assets, profitability and income based on the laws and regulations running the state that the company is headquartered. Additionally, shareholders have voting rights and participate in the company decision-making.

Stocks are classified into common and preferred. Common shareholders are entitled to profits only if the company distributes its retained earnings, whereas preferred shareholders are entitled to a fixed dividend annually. If the company was liquidated, common shareholders are compensated after loan holders, bondholders and preferred shareholders. On the other hand, preferred shareholders have no voting rights.

Let’s look at an example.

Example

Peter owns 2,000 shares of company X for $12 per share, a total worth of $24,000. In the annual general meeting of company X, the management decides to increase its capital through a new issuance. This means that existing shareholders can participate in the share capital increase by acquiring preemptive rights in proportion to the number of total shares held.

The management decides to issue 4 million new shares for $10 each to raise $40 million. The rights issue is 2 for 1, which means that for every 2 shares Peter owns, he will get another 1, so he has the right to buy 1,000 more shares for $10 each, a total worth of $10,000.

After the rights issue, Peter will own 2,000 shares for $12 per share, $24,000 plus $1,000 new shares for $10, $10,000, a total of $34,000. This means that the average share price after the rights issue, also known as ex-rights price will be $34,000 / 3,000 shares = $11.3 per share.

Summary Definition

Define Stock: A stock is a certificate of ownership in a corporation that gives the owner or stockholder certain rights to assets, future profits, and influence how the company is run and operated.

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What Does Stated Value Stock Mean?

Many companies choose not to establish a par value in their charters because it allows them to escape the minimum legal capital requirements that many states have. Since most states’ laws refer to a par value when determining the minimum capitalization thresholds, corporations are able to side step this issue by creating no-par value stock.

Many states have caught on to this strategy, however, and now require companies to use the stated value as the new minimum capital limits. This is a step in the right direction, but management can still manipulate this to a lesser degree by setting an artificially low value.

Let’s look at an example of how the issuance of these shares is recorded.

Example

When Tom incorporates his business, he decides to not include a par value in the corporate charter. Instead, he issues 1,000 shares to himself with a stated value of $1 per share for $500,000. When the company issues the shares to Tom, the common stockaccount is credited for $1,000, the cash account is debited for $500,000, and the additional paid in capital account is credited for $499,000.

Notice the stated-value does not reflect the fair market value or the actual amount paid for the shares. In this way, it is similar to par value shares.

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What Does Small Stock Dividend Mean?

Stock dividends are common in corporate structures where the company doesn’t have enough cash or cash flow to pay investors. Instead of issuing cash dividends, the board of directors declares a stock dividend to keep investors happy. This way investors still get a return on their investment and the corporation doesn’t have to deplete its cash position. These dividends are also common in mergers and corporate restructuring deals.

Example

Let’s take a look at an example of how a stock dividend works. Currently, Krispy’s Bakery has 10,000 outstanding $10 par shares of stock and is authorized to issue another 5,000. Its retained earnings account has a $20,000 balance and the market value of each share is $25. The Krispy board of directors declares a 10% stock to all the current stockholders. This means the total number of outstanding shares will increase 10% after the dividend is issued.

On the date of issuance, 10% more shares will be issued to each shareholder based on their ownership percentage on the day of declaration. This business transaction is recorded by capitalizing the market value of the newly issued and distributed shares. Krispy’s journal entry to record this would event would debit retained earnings for $25,000, credit the common stock account for $10,000, and credit the paid in capital account for $5,000.

As you can see, the small stock dividend transfers $25,000 of retained earnings to common stock (equal to the par value) and paid in capital (equal to the difference between the market value per share and the par value).

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