Common stock represents an investment in a company and a share of its ownership. For investors that include businesses and private individuals, it also represents a financial transaction that requires precise accounting. Accounting for purchasing common stock ensures that you can track your investment and include it properly when you file your tax returns.
Business Stock Purchases
When a business purchases stock as an investment or to acquire another business, it must account for it on its balance sheet. The cost of the stock is an expense, as are any fees the business spends to consult with advisors, work with brokers or investigate the purchase before making it. Shares of the stock itself become a new asset. As its value rises or falls, this will affect the business's net worth and its stockholders' equity. Because stock can be easily sold at its market price, it also adds to a business's cash asset ratio (though spending cash to buy stock reduces the cash asset ratio by a proportionate amount).
Personal Finance Accounting
For private individuals, purchasing common stock presents its own accounting challenges. While most individuals don't keep the same detailed records that businesses need to, they can still keep records indicating how much stock cost. This is useful when you sell shares and need to claim a cost basis to determine your profit, which is the taxable amount. Your cost basis is the amount you spend buying a stock, including the purchase price and associated fees. Invoices and receipts from a broker serve as adequate records for cost basis.
Accounting for Expenses
Investment expenses are eligible for tax deductions if you itemize on your tax return and spend money, other than the money you invest, on a common stock purchase. For example, if you work with a broker to arrange a stock purchase you can deduct the cost of travel to and from the broker's office, money spent on financial publications to research your purchase, broker fees and the cost of software to manage your investment. In the event of an IRS audit, you'll need to present receipts to show that each of these deductions is a legitimate investment expense.
Accounting for Income
Once a business or individual purchases common stock, it becomes important to establish a system for accounting for the income that stock produces. Some stock pays dividends, which investors must claim as taxable investment income. Selling stock creates capital gains or losses, depending on the cost basis, which can reduce your tax liability or increase it. The best way to account for income from recently purchased common stock is to enter all dividends, including those you reinvest, into a ledger, whether it's a corporate balance sheet or a spreadsheet to track personal investments.
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