Par Value

I'd like to take you all into a land that is not my expertise, but is so overly used and abused in the SL Capital Markets that it is necessary to visit once in awhile. That land is accounting, and we'll be travelling to the isle of stockholder's equity in this article, for a topic on the idea of par value of shares.

First, however, it is absolutely vital that everyone who travels to the land of accounting learn the balance equation. This equation is tattooed on the skull of every accountant and accounting major, and they have it in their minds at all times. This ancient secret of bookkeeping reads:

ASSETS = LIABILITIES + EQUITY

This is how I found an error in the SLR balance sheet, and posted about it here.

The assets and liabilities section are fairly straightforward. It seems to be that equity section that trips people up. For that section, I'm going to highlight how to figure the values placed in the "Common Stock" and "Paid-In Capital" lines, because I think it's a topic that is not emphasized enough.

Contrary to about every balance sheet I've looked at in SL, "Common Stock" does not refer to the market capitalization (shares * price) of a company. Instead, when a company sells stock, they should also set a par value for the stock, which is a fictional, very low (L$0.01 is what I've been recommending to those that ask) value to place on the shares. The remainder of the cash you receive is then added to that "Paid-In Capital" line, whose full name is actually "Paid-in capital in excess of par value." When you see the full name, it makes more sense.

Why bother correcting these? Well, if you treat your market capitalization as your equity section, then the accounting equation has to have correspondingly large assets or liabilities to keep in check. This is especially true if you kept a lot of shares back from public holdings. An example would help show this:

Suppose XYZ creates 10,000,000 shares, and sells them for L$1 each. Let's suppose the day afterwards, XYZ stock hits L$3.00 per share. If we use market value on the balance sheet, the company has spontaneously gotten L$20,000,000 richer! But in reality, nothing changed, so this is not an accurate picture.

Instead, the company should record (in my opinion) L$100,000 as common stock, L$9,900,000 as paid-in capital, and $10,000,000 as cash. Then, in subsequent balance sheets, leave the L$100,000 alone, and adjust other lines around it. This will be a better representation of XYZ's true value.

Disclaimer: I'm not an accountant. I'm an actuary. Real accountants, feel free to critique this as needed.

Source: This page of AccountingCoach.com