In the world of finance, one word can have many meanings. It is easy to get confused, whether you’re a beginner or seasoned professional. For example, the very word “asset” can mean money, a right to money, or simply an object that can be converted into money.
Capital is another one of those many-purpose terms, and one of the areas we see it is stock. Stock is another word for the owner’s “pieces” of of the company, but what about capital stock? Is it related to capital assets? The answer is no, and here’s why.
Is capital stock an asset?
The capital stock of a company is not one of its assets. However, capital stock that one company holds in a second company is an asset for the first. Moreover, confusion may arise due to the similarity between “capital stock” and “capital assets,” but this is just a case of faux-amis. Capital stock and capital assets are not the same.
What is capital stock?
Private and public companies alike are broken down into shares, often starting with 100 shares in a private company that become hundreds of thousands (or more) of stocks when the company goes public. A company founder owns all 100 shares in the company, and thus 100% of it. Both shares and stocks are another way of saying “what portion of the equity each shareholder has a right to.”
Capital stock is an account on the balance sheet that designates the original cash contribution to the company that the owner made to acquire 100% of its shares, as well as any additional contributions he/she makes over time.
When the company goes public, the owner exchanges his capital stock for common stock, which is evaluated much higher than the carrying value of the capital stock. He/she can either sell that stock on the stock market or hold on to it, in the latter by simply issuing new stock to new shareholders.
You can determine the book value, or carrying value, of capital stock or common stock by subtracting total liabilities from total assets. However, when public companies issue common stock on the capital markets, the price of the shares are bought and sold at prices unrelated to the equity value of the company. That’s the stock market!
As you can see, capital stock is not an asset at all. It is an equity account on the balance sheet for private companies that shows what the owner(s) originally contributed. However, if that company uses some of its cash to purchase capital stock or common stock in another company, it will record these purchased stocks as assets on its balance sheet. Thus the confusion between stock as equity and as an asset.
To help you visualize, here’s what stocks could look like on the balance sheet. Though I show stocks on both sides, they are not related.
| Assets | Liabilities & Equity |
|---|---|
| Cash… 300,000 Stock holdings in separate company… 450,000 Total… 750,000 | Capital Stock… 750,000 – Initial… 250,000 – Additional… 500,000 Total… 750,000 |
But even then, these stock assets are not capital assets. Capital assets are something else entirely. Let’s look at them now.
What is a capital asset?
A capital asset is, in simple terms, a big item with lasting value whose duration is longer than one year. You can sell a capital asset because it has value that others recognize. Examples include machinery, cars, buildings, and land.
However, small items such as office supplies and cash are not capital assets because they are highly liquid, and their value is usually consumed within one year.
At the same time, a capital asset can be intangible. Patents, trademarks, copyrights, data and other intellectual property also carry value that lasts longer than a year and could be sold to someone in a commercial exchange.
However, an invoice, which gives you the right to collect money from another person in exchange for a product or service, is NOT a capital asset because it’s value lasts less than one year and it cannot easily be sold. It’s what we call accounts receivable.
In summary, assets must have the following characteristics to be considered a capital asset:
- Big and expensive
- Carries value for more than 1 year
- Tangible or intangible
- Can be sold
Imagine you have a truck that you bought new 5 years ago. Is it big and expensive? Yes. Does it carry value for more than 1 year? Yes. Is it tangible or intangible? Yes, tangible. Can it be sold? Yes as a used car. Your truck is a capital asset.
Now imagine you have a keyboard. Is it big and expensive? No. Does it carry value for more than 1 year? Yes. Is it tangible or intangible? Yes, tangible. Can it be sold? Maybe, but not easily. Keyboards are not a capital asset — they’re just too small.
Capital Stock Is Not a Capital Asset
Within a company, capital stock is not an asset at all. It belongs to the equity portion of the balance sheet. However, when one company owns stock in a second, those shares are recorded as an asset.
You might think they should be a “capital” asset since the two share the word, but this is not the case. Capital stock as an asset are highly liquid and can be easily converted to cash within one year without losing value, so they’re simply current assets.
Careful – Percent Stock Ownership is Not the Same as Stock Value
An important thing to remember about capital stock is that ownership and rights are not equal to the capital stock account. A 100% owner that paid $10,000 to launch her company holds capital stock at $10,000 forever.
However, that’s just the balance sheet view. She also holds 100% ownership and rights in the company, which means she owns all of the profits made over time. In other words, she owns all of the company equity, not just the paid in capital.
It’s easy to get confused about ownership rights and capital stock, or paid-in capital, since the value of that account is not equal to the company’s current value. Just remember, regardless of her capital stock, company owners have the right to 100% of the equity value.
Feature Photo by David Vincent on Unsplash
