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Q: Accounting for stock and stock-option transactions ( Answered 4 out of 5 stars,   0 Comments )
Subject: Accounting for stock and stock-option transactions
Category: Business and Money > Accounting
Asked by: mktc-ga
List Price: $30.00
Posted: 05 Sep 2006 10:31 PDT
Expires: 05 Oct 2006 10:31 PDT
Question ID: 762415
I need to understand the basic principles of accounting for stock and
stock options transactions.

Double-entry accounting is the standard for tracking the flow of money
in businesses, but assets are never explicitly accounted for.  That
is, in a standard accounting system, when you buy, say, a tractor for
$10000 cash, you would debit your cash account $10000 and credit your
assets account $10000, but you would never credit 1 tractor to any
account.  That information is held implicitly.

However, when accounting for stock and options transactions, you need
to handle that part of the transaction explicitly.  I need to know the
standard way of doing this.

I need answers to the following sub-questions (assume a reference
transaction of a buy of 100 shares of IBM for 81.00):
* Do you account for the stock transactions as a double-entry?
* If so, what is the standard place to put the debit of 100 shares of IBM?
* If the standard is to use a single entry for the stock transaction,
presumably you still use double entry for the cash part of the
transaction (a debit and credit of $8100 respectively), how do you
link the two transactions to maintain a balance sheet?

Please include any references you find in your research, especially
tutorials, or basic materials about this type of accounting.  Please
do not include any references to general double-entry accounting
topics, I'm up to my eyeballs in those.
Subject: Re: Accounting for stock and stock-option transactions
Answered By: elmarto-ga on 05 Sep 2006 13:31 PDT
Rated:4 out of 5 stars
Hello mktc!
The most important concept you should internalize is that the
double-entry method ALWAYS holds. For each transaction that a firm
performs, there must be credits and debits that add up the same
amount. This is always true.

Your example about the tractor is actually incomplete. It's true that
you do not credit "1 tractor" in the balance sheet. However, the
tractor can be considered an "Equipment", which belongs in the assets
account. Therefore, the value of the tractor will be credited into
"Equipment". For example, assume the firm starts out with only $50,000
in cash and already has some machinery and tools valued at $50,000.
The balance sheet could look like this:

Assets                  Liabilities
Cash       50,000
Equipment  50,000 
                        Equity   100,000
Total     100,000       Total    100,000

After buying a tractor using $10,000 cash, the balance sheet would look like this:

Assets                  Liabilities
Cash       40,000
Equipment  60,000 
                        Equity   100,000
Total     100,000       Total    100,000

When buying stocks, the idea is not very different. Depending on how
long you're planning to hold the stock you're buying, either the
"short-term investments" or "long-term investments" accounts (both of
which are assets) should be credited. Since the shares are usually
bought with cash, the Cash account should be debited with the cost of
stock purchase. So, as you see, the double-entry principle would still

Let's follow your IBM example. Let's assume the firm I showed above
(the one which just bought the tractor) has bought 100 IBM shares at
$81 each, and is planning to keep them for the long term. The balance
sheet would then become:

Assets                           Liabilities
Cash                   31,900
Equipment              60,000 

Long Term Investments   8,100
                                 Equity   100,000
Total                100,000     Total    100,000

You can find another example in the Powerpoint presentation from the
following link:
(slides 7-45, especially 18-19)

This presentation also explains how to adjust for changes in the stock
price, how to account for dividend payments, etc.

It's possible that what's confusing you is the fact that firms usually
prepare an annex to the balance sheet in which they show which stocks
they are holding and what is their value. This annex, of course,
doesn't follow the double-entry principle, because it's just a break
up of the "Investments" accounts (Short Term and Long Term) which are
shown in the Assets side of the balance sheet.

For example, let's assume that the firm now buys 100 shares of
Microsoft at $19 each, and is also planning to keep them for a long
time. The balance sheet would become:

Assets                           Liabilities
Cash                   30,000
Equipment              60,000 

Long Term Investments  10,000
                                 Equity   100,000
Total                100,000     Total    100,000

And the Investments annex would look like this:

Short Term Investments

Long Term Investments
    100 shares of IBM @ $81       $8,100
    100 shares of Microft @ $19   $1,900
Total                            $10,000

I hope this helps! If you have any doubt regarding my answer, please
don't hesitate to request clarification before rating it. Otherwise, I
await your rating and final comments.

Best wishes!

Request for Answer Clarification by mktc-ga on 05 Sep 2006 14:38 PDT
OK, so I think I get it.  The "annex" explaining the total of the
"long term investments" item, is simply a list of holdings (or
presumably, in the case of short sales, shorted securities).  It
therefore, as you point out, doesn't follow the double entry
procedure.  So in that way, it's not really part of the accounting
system.  Are there any standard terms or procedures for maintaining
this list that I should know about?  Or does each organization do it
differently?  For example, there are a million different ways to
identify securities: NYSE symbol, Reuters symbol, ISIN, common name,
etc.  Are there standard procedures for maintaining this list in the
face of mergers, spinoffs, symbol changes and other corporate actions
involving the held securities?

I guess my question really does boil down to how to maintain that "annex".

Clarification of Answer by elmarto-ga on 06 Sep 2006 08:35 PDT
There aren't any standard procedures for preparing the annex, as its
mainly for record keeping of the company, and it doesn't have to be
filed at the SEC. Therefore, each company will choose the method it's
more comfortable with.

The actual SEC filing will probably include information about the
investments, but not in such detail (i.e. it will not tell how many
shares were bought, price paid, etc). As an example, check Google's
10-K SEC filing:

Check page 88 of the report. As you can see, it shows how much money
is invested in "Municipal Securities", "US government notes", "US
Corporate Securities", but no further detail is given. The actual
details are kept in the way they see fit. With the use of computers,
corporate actions as the ones you describe should be fairly easy to
account for in the value of the stock holdings.

Best regards,
mktc-ga rated this answer:4 out of 5 stars

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