Is Common Stock An Asset, Liability, or Equity? Answered Once And For All - Fervent | Finance Courses, Investing Courses (2024)

You started to learn Accounting or go through financial statements and stumbled upon one of the most frequently asked questions… Is common stock an Asset, Liability, or Equity? Here’s your answer once and for all. And why it’s true.

TL;DR

Common stock is Equity.

It cannever be seen nor classified as an Asset or Liability.

If you’d like to learn more aboutwhy this is true, keep reading. Otherwise, you have the answer you were looking for; have a great day!

Is Common Stock An Asset, Liability, or Equity?

Common Stock is a form of Equity.

More accurately, Common Stock iscategorisedunder the ‘element’ of Equity within the Balance Sheet (aka Statement of Financial Position). More on this further down.

This is ultimately because it represents the shares held by common stockholders or common shareholders.

No item can be categorised into two separate elements. In other words, if something is Equity, itcannot be an Asset or Liability.

Similarly, if something is an Asset, then it cannot be a Liability or Equity.

Thus, since Common Stock is a form of Equity, it cannot be an Asset or a Liability.

Now, this is just one way of looking at things.

We can also see things from a different perspective and start by exploringwhy Common Stock isnot an Asset or Liability.

Why is Common Stock Not An Asset?

Broadly speaking, an ‘Asset’ in the context of Accounting is something that a company:

• Owns,
• Controls,
• As a result of a past transaction,
• Which can be reliably measured, and
• From which it expects to gain future economic benefits.

Anything that doesn’t meet any one of the 5 criteria above cannot be deemed an ‘asset’.

Common stock is not ownedby the company. It’s owned by the shareholders of the company.

The company doesn’t control common stock; rather, it is the shareholders who control the company.

With 2 of the 5 criteria already not being applicable, it’s clear that Common Stock isnot an asset for a company.

For investors, however, common stockcan be seen as an asset.

For instance, if you own shares in Apple Inc., you’d technically own some of its ‘common stock’. As far as you’re concerned, that’s an asset for you. But as far as Apple Inc. is concerned, the shares you own will be categorised under/as ‘Equity’ in their Balance Sheet (aka Statement of Financial Position).

Why is Common Stock Not a Liability?

Broadly speaking, a ‘Liability’ in the context of Accounting is something that a company:

• Owes,
• As a result of a past transaction,
• Which can be reliably measured, and
• To which it expects to incur future economic costs.

As with the criteria for Assets above, anything that doesn’t meet any one of the 4 criteria above cannot be deemed a ‘liability’.

A company does notowe common stock to anyone.

While common stockholders are entitled to cash dividends, companies aren’t legally obliged to pay dividends.

Thus, technically, it’s possible for a company to incur 0 future economic costs to common stockholders (although this isn’t likely).

Why is Common Stock Equity?

This brings us back to the final element of ‘Equity’.

Equity represents the net worth of a company. It also represents the value of the company that is attributable to shareholders as a whole.

Shareholders are entitled to two primary forms of monies from companies:

1. Their initial investment (this is represented by ‘Common Stock’), and
2. Earnings that are distributable to shareholders (sort of – but not entirely – represented by Retained Earnings).

Note that Retained Earning technically represents earnings of the business that are retained for reinvestment into the business.

However, since shareholders ultimately own the company, those Retained Earnings can be paid out to them should the board of directors and shareholders agree to such a payout.

The board of directors will typically evaluate such a request while considering the firm’s future plans and its free cash flow.

At a fundamental level, given that Common Stock essentially represents the shareholders’ investment in the business, it’s only logical that it should show up under ‘Equity’ andnot under Assets or Liabilities.

Can Common Stock Ever Be An Asset?

From the company’s perspective, Common Stock cannever be an asset.

It can only ever be seen as ‘Equity’, and will never form any part of the firm’s total assets (neither current assets nor non-current assets).

As highlighted earlier, however, Common Stock canbe seen as an asset from aninvestor’s perspective.

Can Common Stock Ever Be A Liability?

From the company’s perspective, Common Stock cannever be a liability.

It can only ever be seen as ‘Equity’, and will never form any part of the firm’s total liabilities (neither current liabilities nor non-current liabilities).

A different type of stock, ‘Preferred Stock’ can be seen as a Liability.

We’ll touch on the difference between common stock vs preferred stock further down.

But for now, hopefully, you’re no longer asking/wondering is Common Stock an Asset, Liability, or Equity.

Common Questions on Common Stock

Let’s now consider some other questions you likely have on your mind about Common Stock, shall we?

Is Common Stock On The Balance Sheet Or Income Statement?

Common Stock shows up on the Balance Sheet (aka Statement of Financial Position), andnot on the Income Statement (aka ).

This is fundamentally because the Income Statement reports Income and Expense items, while the Balance Sheet reports Assets, Liabilities, and Equity items.

As we established earlier in this article, Common Stock is an ‘Equity’ item, and therefore shows up on the Balance Sheet.

Now, note that Common Stock can also show up on the Statement of Changes in Equity, but not all companies need to prepare and publish that particular financial statement.

Thus, the Balance Sheet is the most relevant financial statement for Common Stock.

Where Does Common Stock Go On The Income Statement?

Trick question, this.Common Stock doesnot go on the Income Statement.

Common Stock goes on the Balance Sheet under ‘Equity’.

What Is The Difference Between Common Stock And Equity?

Oftentimes, people wonder what the difference between Common Stock and Equity is. Technically, they’re not something to compare and contrast as such.

Common Stock is aform of Equity. It belongs within the ‘element’ of Equity.

Equity, in the context of Accounting, broadly comprises of:

• Common Stock, and
• Retained Earnings

Itcan also comprise of other items like Share Premium, Reserves, etc, however, this isn’t always the case for every single company.

On the flip side,every single company must have Common Stock and Retained Earnings under the ‘Equity’ section of the Balance Sheet.

Is Common Stock Equal To Total Equity?

Common Stock is not necessarily equal to Total Equity. It canbe equal to it, if and only if Retained Earnings is equal to 0.

This is because Equity, in the context of Accounting, broadly comprises of:

• Common Stock, and
• Retained Earnings

Put differently…

Equity = Common Stock + Retained Earnings

Now, if Retained Earnings is equal to 0, then the equation becomes…

Equity = Common Stock + 0

Thus, if Retained Earnings is equal to 0, then…

Equity = Common Stock

In all other instances, however, Common Stock willnot be equal to Total Equity.

How Does Common Stock Differ From Preferred Stock?

Common Stock gives shareholders voting rights, whereas Preferred Stock – generally speaking – does not.

This means that if you want to directly influence decision-making within a company as a shareholder, you’ll almost certainly want to own common stock instead of preferred stock.

Preferred stock gives its holders ‘preferential rights’ in terms of income. Essentially, preferred stockholders are legally entitled to a form of income (typically ‘preferred dividends’ which tend to be pre-determined).

This legally binding requirement to pay preferred stockholders their ‘preferred dividends’ is one of the main reasons that Preferred Stock can be seen as a Liability (and not necessarily Equity).

In the event of insolvency or bankruptcy, preferred stockholders are ahead of the queue vis-a-vis common stockholders in terms of access to the firm’s net assets.

Common Stockholders arelast in linein terms of access to the firm’s net assets in the event of insolvency or bankruptcy.

Wrapping Up

Hopefully, it’s now abundantly clear that Common Stock isEquity.

Or, strictly speaking, it’s aform of Equity in that it’s categorised under ‘Equity’ section within the Balance Sheet (aka Statement of Financial Position).

Common Stock isnot an Asset nor is it a Liability.

Preferred Stockcanbe seen as a Liability, although it is sometimes treated as Equity, too.

If any part of this article isn’t clear, please do give it another read.

If concepts within Accounting are confusing you, it’s worth starting by learning about the Accounting Process.

Alternatively, if you’re looking to apply accounting concepts to your investments, then check out our Stock Valuation coursewhich shows you how you can leverage the power of multiples to value stocks from scratch.

Also take a look at our Capital Budgeting course (aka ‘Investment Appraisal’) to explore how related concepts can help you better appraise investments and projects.

That’s a wrap from us for now though. Have a great time learning!