No-Par-Value Stock
Refers to stocks issued without a designated par value or stated value
What is No-Par-Value Stock?
No-par-value stock refers to stocks issued without a designated par value or stated value. Hence, the declared value of the stocks owned will not be mentioned in the stock certificates. Usually, stocks are known to be sold above their stated value.
Whenever a corporation raises capital through its investors, it issues shares of stock in exchange for the investors' contributions. Often, the buyers purchase those issued shares from the company at a price higher than the predetermined par value.
The difference between the predetermined stated value and the price the buyer pays for the stock (the market value) is called additional paid-in capital (APIC). It is recorded in the shareholders' equity section of the balance sheet.
The total sum of money that the company gathers from its shareholders when it sells its stock is called paid-in capital. Therefore, it includes the par value of the shares sold and the extra cash paid over par.
The par value of the stocks sold usually represents a small portion of the total shareholders' equity. Other essential accounts in the shareholders' equity section include treasury stock and retained earnings.
However, some corporations also issue their stocks without a predetermined price in the first place. The shares are sold in the market at the prices determined by the market.
Whenever shares are sold without a stated value, the total capital raised is recorded in the capital stock (or common stock) account in the shareholders' equity section of the balance sheet. There is no need for the creation of an additional paid-in capital account.
As a simple example, suppose a company issues all of its stocks without a predetermined par value. The total capital collected from the investors was $100,000. This means that that sum of money will be recorded in the capital stock account alone.
The number of shares issued is shown under corporate planning in the corporate charter (also known as articles of incorporation and articles of incorporation). Also, any issuance of shares must be accepted by local governors and the federal Securities and Exchange Commission.
Most of the time, companies require the assistance of underwriters. They ensure that the capital stock is being issued at the predetermined price (if any), and the investment for the capital sold is available for the company on a particular date.
Key Takeaways
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No-par-value stocks are shares that are issued by corporations without a predetermined par value.
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The prices of such stocks are determined in the market by fundamental forces such as supply and demand, like any other stock.
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The par value of a stock, also known as the stated value, is the lowest price for which the shares will be sold to the public.
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The advantage of selling stock without a par value is avoiding liability towards investors in case the market value of the stock went below the stated value.
Understanding no-par-value stocks
A company willing to increase its shareholders' equity balance can do so in two different ways:
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Receive money from investors in exchange for shares of the company
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Retain additional profits the company brings in a specific time frame
Issuing no-par-value stocks are related to the first option. As mentioned, stocks with no stated value can be sold in the stock market. The total capital raised is added to the shareholders’ equity, usually to the balance of the account called capital stock.
Most corporations issue shares of their companies with a par value. However, they are usually very low, like a dollar or ten cents a share. Hence, when sold, those shares' market value will almost always be higher than that stated value.
Reasons for Issuing No-Par-Value Stocks
So why would companies assign a par value for their stock if the shares will be sold at a higher price? There are two main reasons that corporations give these stated values:
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It guarantees potential investors that the issuing business wouldn't sell its shares for less than their face value during its initial public offering
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The company will ensure that, by selling the shares, it will raise a minimum amount of capital regardless of the market price at which the stocks were sold
That being said, companies that sell their shares with a par value will have a legal liability toward their investors. That becomes an issue when the stock price falls below the stated value. At that point, the company would be liable to its shareholders.
For example, suppose a company issues 100,000 stocks at a par value of $5 a share. The company is raising at least $500,000 in capital stock. However, the shares are currently trading at $1 per share.
This means the company has a liability of $4 a share to its investors. Therefore, it has a total liability of 4*100,000 = $400,000. That is why many companies if they decide to issue shares with a par value, do so at a very low price - as low as a cent!
However, some states permit stocks to be authorized without a predetermined stated value. This can eliminate the theoretical liability that the company can be subjected to, as discussed previously.
In this way, there is no minimum amount of capital that the corporation must raise. The shares will be sold at prices determined solely by market forces. People will pay as much as the perceived value of being partial owners of the company, which is characterized by the following:
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Future cash inflows investors expect from the shares
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Technology that the company owns
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Prospects of the company and the industry
Issuing stocks at shallow stated values gradually eliminates the need for having indicated value in the first place. As a result, more state governments are permitting no-par-value stock issuances. It may reach a point where we abandon par value stocks altogether.
Par value of a stock
The par value of a stock, also known as the stated value, is the lowest price for which the shares will be sold to the public. It can be thought of as the minimum benchmark of capital stock that the company must have in its books to safeguard its creditors.
Also known to represent the legal capital per share, the par value marks the minimum amount of capital for each share being issued.
The stated value of the shares must be shown separately in a company's balance sheet, although it usually takes on a small chunk of the shareholders' equity.
During a company's initial public offering (IPO), the company must decide the par value of the stocks sold in the primary market. The stated value determined depends upon multiple factors:
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The initial market capitalization the company aims to achieve
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The number of public shares that will be issued as well as the original owners' portion of ownership
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The forecast of stock prices after the initial selling in the market.
The par value of shares can be set at levels as low as one cent per share. That is why, most of the time, it has almost no relevance in the stock market. Also, some corporations don't have a stated value for their stocks in the first place.
The price for which the stocks are initially sold is usually way above the par value. Hence, it is not an indicator of the stock's market value. The stated value of a stock can be as low as one cent, yet it can be sold for hundreds of dollars.
In the books, the par value of the total shares outstanding must be written under the "capital stock" account. The balance in that account equals the outstanding shares multiplied by the stated value.
Any additional capital raised (because of the higher price for which the shares were sold) is written under the "additional paid-in capital" account. With a par value of 0, the capital raised is directly added to the capital stock account.
Accounting Entry of Par Value and No-Par-Value Stocks
As mentioned, when a company issues stock without a stated value, it would have to record all the capital raised in an account called capital stock in the shareholders’ equity section of the balance sheet. The cash account is debited, and the capital stock account is credited.
Had the company sold the shares with a par value, the stated value of the stocks (the stated value multiplied by the number of shares) would have been credited to the capital stock account.
If the shares were sold at a price higher than par, the additional money would be credited to the APIC account.
It is important to note that issuing stock does not create an asset. It allows the company to acquire assets like cash by selling shares. The following examples show how cash accumulation by selling shares is recorded as capital stock.
Suppose a theoretical corporation plans to list on a public exchange, authorizing the following:
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600,000 shares of class A common stock
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200,000 shares of class B common stock
However, the company only issues 200,000 class A and 50,000 class B shares. It aims to sell the remaining later than its IPO (initial public offering). Therefore, it is planning to sell 250,000 shares of the 800,000. The shares sold for an average of $10 per share in the market.
First case: The company sells the shares without a par value
Suppose this company is reluctant to assign a par value to its shares to avoid the possibility of its price plummeting below the stated value. By doing this, they wouldn’t have a legal liability toward the corporation’s stakeholders.
Since there is no par value when the stock is sold, all the capital raised will be credited to the “capital stock” account. The total capital raised is equal to: 250,000 * $10 = $2,500,000, all of which is credited to capital stock.
The journal entry will be as follows:
| Debit | Credit | |
|---|---|---|
| Cash | $2,500,000 | |
| Capital Stock | $2,500,000 | |
| Issued 250,000 shares with a par value of $0 at $10 a share |
The total capital raised is recorded in the capital stock account.
After raising the capital, the shareholders’ equity section of the balance will appear as follows (we will assume retained earnings to be $50,000):
| Stockholders’ Equity | |
|---|---|
| Capital stock: $0 par value; $10 market value; authorized, 250,000 shares; issued and outstanding, 250,000 shares | $2,500,000 |
| Additional paid-in capital | 0 |
| Total paid-in capital | $2,500,000 |
| Retained Earnings | 50,000 |
| Total stockholders’ equity | $2,550,000 |
Second case: The company sells the shares with a par value
Suppose the company is willing to sell the shares with a par value of $1. This is to guarantee that at least $250,000 of capital is raised. Since the shares are sold at $10, the total capital raised equals $2,500,000. This sum is split between:
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Capital stock ($250,000),
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Additional paid-in capital ($2,250,000).
Therefore, cash increases by $2,500,000, capital stock increases by $250,000, and APIC increases by $2,250,000. Total stockholders’ equity increases by $2,500,000.
The journal entry will be as follows:
| Debit | Credit | |
|---|---|---|
| Cash | $2,500,000 | |
| Capital Stock | $250,000 | |
| Additional Paid-in Capital | $2,250,000 | |
| Issued 250,000 shares with a par value of $0 at $10 a share |
In this case, the company records additional paid-in capital in its books. APIC does not imply that the company has made a profit. It is simply part of the total investment raised by the company. APIC is combined with capital stock to represent total stockholders’ equity.
After raising the capital, the shareholders’ equity section of the balance will appear as follows (assuming retained earnings amount to $50,000):
| Stockholders’ Equity | |
|---|---|
| Capital stock: $1 par value; authorized, 250,000 shares; issued and outstanding, 250,000 shares | 250,000 |
| Additional paid-in capital | 2,250,000 |
| Total paid-in capital | $2,500,000 |
| Retained Earnings | 50,000 |
| Total stockholders’ equity | $2,550,000 |
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