Accounting for Stock Subscriptions – US GAAP

Stock subscriptions are a process that allows investors and employees of a company to purchase stocks over a long period. Investors can subscribe (buy stocks) for stocks in regular intervals.

A company may enter into a formal stock subscription agreement with a corporation. Another option for the company is to offer the subscription directly to selective shareholders, which is called placement.

The ASC 505-10-45-2 guides the accounting treatment of stock subscriptions. Although the topic does not directly regulate stock subscriptions but rather under the subtopic of notes received by the company.

What is a Stock Subscription?

A stock subscription is an offer or agreement to investors to buy stock of a company at specified intervals. Stock subscriptions can be offered to the company’s employees, shareholders, private investment firms, or corporations.

Stocks issued for the subscription arrangement come with rights attached. Each subscriber has the option to buy stocks in the existing proportion of the shares held.

Stock subscriptions are offered directly by the issuing company. The advantage for the company is to raise capital directly. Another benefit is to compensate employees in the form of additional shares.

The subscribers receive additional shares without paying commission. Thus, the arrangement is a cost-saving one for both parties.

Stock Subscription Rights

In a stock subscription right offer, the existing shareholders of a company can retain their proportion of shareholding by subscribing to the new shares.

The company raises additional capital through a rights issue. Shareholders have the right but not an obligation to subscribe to the rights offered. If the shareholders do not subscribe to the offer, their ownership rights will be diluted as new shares will be sold in the secondary market.

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Stock subscription rights are offered to existing shareholders on a pro-rata basis. It means if fully subscribed, all shareholders will receive new shares in proportion to their previously held shares.

Companies usually offer stock subscription rights at a discount to the market price of their shares. The discount offered is to attract existing shareholders.

Stock Subscription Agreement

Similarly, an issuing company can offer stock subscriptions to corporations and equity investors. The company can also offer new stock to an investor privately, which is termed a private placement.

Both parties can make the arrangement in the form of a formal stock subscription agreement. Commonly, investor companies make payments in installments for stock subscriptions.

Accounting for Stock Subscriptions in US GAAP

The accounting treatment for stock subscriptions can be recorded according to the guidelines offered in ASC 505-10-45-2 for notes received by a company.

sometimes, companies report the stock subscriptions as an asset on the balance sheet. For subscriptions receivable in the short term, the subscription is reported as a current asset, otherwise as a non-current asset.

Subscription stocks do not have actual rights like common stock issued by a company. Thus, the SEC requirements are different. The subscription stocks should be recorded with a contra equity account on the balance sheet.

Companies should create a stock subscription account instead of the commonly used capital stock account.

The ASC 505-10-45-2 states that the equity received in the form of notes receivable should not be recorded as an asset except for the limited circumstances. The rare situations are where the intent and ability to make the payment are visible in a short period.

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The ASC states that such notes receivable should be recorded as a reduction to equity. In some cases, when the cash is received before issuing the annual financial statements (in a short period), the entity can record these notes as assets.

Full and Partial Subscriptions

Common stocks are issued at par or stated value by most companies. Thus, the subscriptions should also be recorded at the same par or stated value.

The excess amount above the par value should be recorded in the additional paid-in capital account. The additional paid-in capital account will be the same as used by the company to record earlier amounts for already issued shares.

If the issuing company does not have a par value for its common stocks, the entire amount received through stock subscriptions should be recorded in the stock subscription account.

If the stock subscriber makes the payments in installments, the company will record the proceeds as and when received. The amount received should be debited with cash and credited for the stock subscription receivable account.

The debit entry to the common stock account will be entered only when subscription stocks are issued. The transaction is recorded when the amount is paid in full and stocks are issued.

Working Example

Let us understand the accounting treatment of stock subscriptions with the help of simple examples.

Suppose ABC company has 100,000 shares in issue at a par of $1 common stocks.

Scenario 1:

ABC offers 50,000 new shares at par with an investor company. Suppose the investor company subscribes in full.

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The journal entries to record this transaction will be:

Stock Subscription Receivable$ 50,000 
Common Stock Subscribed $ 50,000

When ABC company receives cash and the investor company receives stocks:

Cash$ 50,000 
Stock Subscription Receivable $ 50,000
Common Stock Subscribed$ 50,000 
Common Stock $ 50,000

Scenario 2:

ABC company issues 10,000 new preferred shares at a par price of $ 30 are offered at a market price of $ 50.

Suppose an investor company enters into a subscription agreement. The company agrees to make the payment in two installments.

When the first installment is made:

Cash$ 250,000 
Stock Subscription Receivable$ 250,000 
Preferred stocks subscribed $ 300,000
Additional Paid-in Capital $ 200,000

When the investor company makes the second installment:

Cash$ 250,000 
Stock Subscription Receivable $ 250,000
Preferred stocks subscribed$ 300,000 
Preferred Stocks $ 300,000

What if the Subscriber Defaults on the Obligation?

In case the investor company or any other party fails to meet the obligation of a stock subscription agreement, the local laws will provide the guidance. In some jurisdictions, the company will forfeit the entire stock subscription arrangement.

In other jurisdictions, a company may record the already received amount from the stock subscription agreement. The stocks will be recorded in proportion to the amount received by the company. In either case, the local laws prevail for non-obligation to the stock subscription scenarios.

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