Lump-Sum Sale of Securities
The term lump-sum sale of securities refers to common stock issued by a company in combination with other securities such as preferred stock or bonds. When one company acquires another, it oftentimes combines two or more securities as part of the purchase price. Companies can use the proportional or incremental methods to allocate the purchase price to each class of security on its balance sheet.
Normally, companies will sell common stock, bonds, and preferred shares separately. This allows the company to accurately allocate the proceeds received to each class of security on its balance sheet. Occasionally, a company will bundle two or more classes of securities in exchange for a lump sum payment of cash or even an asset. A lump-sum sale of securities oftentimes occurs when one company acquires another.
Transactions involving a lump-sum sale present the company with an accounting challenge, since the proceeds from the sale must be allocated to each class of security on the company’s balance sheet. Generally, there are two methods a company can use to calculate this allocation:
- Proportional Method: if the fair market value of each type of security is known, the lump sum received is allocated to each class of security based on its proportion of the total.
- Incremental Method: if the fair market value of each type of security is not known, the lump-sum received is first allocated to those securities that have a known market value, while the remainder of the lump-sum is allocated to those securities with an unknown value.