Under the third type, we find the law authorizing the capitalization of any and all kinds of property—in the absence of fraud, of course—provided that a full statement is put on record showing the amount of stock and the exact manner in which it is paid for. The amount of cash received must be shown; the property acquired so labeled as to render identification possible; and any payments for services or other expenses must be shown. The attitude taken is that a prospective investor, provided with these facts about the company, can make his own judgment as to stock values.
Thus, we find that practice is not uniform in these regards. From the viewpoint of theory, any accounting treatment of the issue of stock which shows the full facts with regard thereto may be considered as meeting all reasonable requirements.
Treatment of Discount or Premium
Valuing capital stock when issued for cash presents no problem in itself, but the treatment of the discount or premium incident thereto requires consideration. In most of the states and in Great Britain stock cannot be issued below par. The manner of nullifying this provision has already been referred to in [Chapter I]. There it was shown how the issue of fully paid stock is made for property and how treasury stock is created by donation, which may then be disposed of for any price obtainable, without any additional liability attaching to it. In most of the states and in Great Britain, however, a sales commission is allowed which has, in some instances, been used as a cloak for sales at a discount. The booking of the discount or premium presents no difficulties, but the manner of handling it on the balance sheet is not uniform. Premium or discount on stock should be recorded as such on the books, under titles of definite meaning.
One occasionally hears the argument that the discount on stock is a necessary expense incident to financing the company, a sort of “cost of getting started,” an expense without which the enterprise could not be launched; accordingly the discount should be properly capitalized as a part of the property costs. The argument is plausible but not convincing. The information as to the discount on stock is very necessary to the prospective creditor or investor and should always appear as a separate item on the books. To the same effect is the ruling of the Interstate Commerce Commission that premiums on capital stock must be carried on the book permanently unless offset by discounts later allowed. Discounts may be extinguished by premiums, assessments, surplus, or by the retirement of an equivalent amount of stock.
A premium on stock may be looked upon as similar to a capital surplus. It represents a fund of capital originating upon the inception of an enterprise, and is in no sense an increase of capital, i.e., of net worth, due to operation. So far as the law is concerned, there is nothing to prevent the return of this surplus to the shareholders in the form of a dividend. To treat it as available for ordinary dividends, however, would seem not to be in keeping with the manner of its origin. Rather should it be set aside as a permanent surplus. One requirement in the case of national banks is the creation of a permanent surplus equal to 20% of the capital, and so, frequently the original subscribers agree to take their stock at a 20% premium, this premium providing the legal surplus required. In the case of discounts no accounting principles are violated if they are allowed to remain on the books. If there is a surplus from premiums, that should be used to wipe off any discounts. In the absence of premium or other capital surplus, conservatism usually sanctions the use of operating surplus for this purpose, thus bringing the value of the net properties owned at least into equivalence with the par value of the stock.
Valuation of Stock Issued for Property
The difficulty of valuing stock when issued for property has already been stated and the attitude of the laws towards any valuation placed on the properties taken over has been shown. Nothing further here need be said except to state that where also a bona fide sale of a portion of the stock takes place for cash at the same time, a fairly reliable basis for valuing the stock given for the property is offered. It is not the usual practice to show the probable discount on the stock, although such treatment would be logical and consistent with the facts. A similar valuation of the stock might be secured by an independent appraisal of the properties taken over, but this, if done, is not often made the basis for entry on the books. If all the facts are fully recorded, that probably is as much as can be hoped for under the conditions now prevailing. Undoubtedly the use of no par value stock for incorporations of this kind offers the best solution of the problem. With regard to booking the properties acquired by a stock issue, attention is here called to the method of valuation of the individual units by an appraisal committee usually appointed from among the directors and the use of their findings as the basis for the book entries of the transaction.
Valuation of Treasury Stock
In connection with the purchase of properties by stock, there often arises the need of working capital. This is frequently furnished by the pro rata donation or return of some of the stock to the corporation, the sale of which furnishes the necessary working funds. As illustrated in an earlier chapter this donation is booked at the par value of the stock, the charge being to Treasury Stock and the credit to Donated Surplus, Donated Working Capital, or other similar account. Being true treasury stock, it can be sold at any price without liability. It is usually disposed of at a discount which must be recorded on the books either as a charge to Discount on Treasury Stock account which will later be closed against Donated Surplus or as a charge direct to Donated Surplus. Thus when the treasury stock is all disposed of, the net credit balance in Donated Surplus shows the real amount of working capital obtained through the donation. If not entirely sold, the portion sold gives a fair basis for the valuation of the unsold portion, although this value is seldom brought onto the books, it being used as a guide to financing rather than as an item to be regarded in accounting valuation.