A share premium account shows up in the shareholders’ equity portion of the balance sheet. The share premium account represents the difference between the par value of the shares issued and the subscription or issue price. It's also known as additional paid-in capital, or contributed surplus and can be called paid-in capital in excess of par value. This account is a statutory reserve account, one that's non-distributable.
The share premium can be money received for the sale of either common or preferred stock. A balance is recorded in this account only when there's a direct share sale from the company, usually from a capital raise or initial public offering. Secondary trading between investors does not impact the share premium account.
Key Takeaways
- Share premium is the credited difference in price between the par value, or face value, of shares, and the total price a company received for recently-issued shares.
- The amount credited in the share premium account typically fluctuates quarter-to-quarter as a company issues new shares at market value, rather than at the par value.
- The share premium cannot be used for distributing dividends or any other payouts and can only be used for whatever has been expressly laid out in the company's bylaws.
- A share premium account appears in the shareholders' equity section of the balance sheet.
Example of Share Premium Account
Many companies issue shares at nominal par value, such as $0.01 per share, meaning many companies will have a share premium account balance.
For example, say a company issues 1,000 shares at a par value of $0.01 per share. The company actually received $15 per share during an offering. The difference between the par value and the subscription amount is the share premium. Ten dollars is credited to the common stock account and the additional $14,990 is credited to the share premium or additional paid-in capital account.
A share premium account can be used to write off certain expenses, such as the cost of underwriting, commissions paid, and certain discounts. The accounts can also be used to issue bonus shares.
Uses of Share Premium Account Funds
The value of a share premium account likely changes over time as a company issues new shares at the market value as opposed to the par value.
The funds in the share premium account cannot be distributed as dividends and may only be used for purposes outlined in the company’s bylaws or other governing documents. Often, the share premium can be used to pay the expenses of issuing equity, such as underwriter fees or for issuing bonus shares to shareholders.
Beyond selling shares above par, the share premium account can be credited if the government donates land to the company.
Such expenses that can be written off include commissions paid and discounts allowed. Buybacks can also reduce this account—that is, if the sale price was less than the repurchase price, the difference is debited to additional paid-in capital.
Share Premium Example
For example, a company buys back 1,000 shares at $10 a share, where the par value is $0.01. The original price from the initial sale of this stock was $5 a share. The transaction would be a $10 debit to common stock, $4,990 debit to additional paid-in capital, and a $5,000 debit to retained earnings. Plus, the $10,000 credit to the cash account used for the purchase.
Share Premium and Shareholders' Equity
The shareholders’ equity portion of the balance sheet shows the initial amount of money invested in the business. The shareholders’ equity also lists retained earnings as the value of net earnings not paid out as dividends.
Retained earnings are often used to pay off debt, reinvest back into the company for research and development purposes, or for a new business or capital acquisitions. A company’s net earnings, after taxes, and its retained earnings represent the total net worth of the company. If a net loss is greater than the retained earnings, there are negative retained earnings shown as a deficit.
The share premium, or the additional paid-in capital account, and retained earnings are usually the two biggest components of shareholders’ equity. In terms of the shareholders’ equity, the first account is usually the common stock account followed by the additional paid-in capital account. Other accounts appearing in the shareholders’ equity section of the balance sheet can include accumulated other comprehensive income, treasury stock, and unearned compensation.
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The share premium account holds a crucial place within a company's financial structure, prominently displayed in the shareholders' equity section of the balance sheet. It represents the surplus generated when shares are issued at a price higher than their par value, indicating the additional value investors are willing to pay above the nominal value of the shares.
This account, also known as additional paid-in capital or contributed surplus, serves as a statutory reserve, demonstrating the financial health and investor confidence in the company. Importantly, it arises only from direct share issuances by the company, such as initial public offerings (IPOs) or capital raise activities, and not from secondary market trading among investors.
The share premium account's balance varies as a company issues new shares at market value rather than at par value, reflecting changes in the company's financial performance and its ability to attract investors at premium prices.
It's crucial to note that the funds within the share premium account cannot be distributed as dividends; they are reserved for purposes explicitly outlined in the company's bylaws or governing documents. These funds might be utilized for various purposes such as offsetting expenses related to equity issuance (like underwriter fees), issuing bonus shares to shareholders, or writing off certain costs like underwriting expenses, commissions, or discounts allowed.
Furthermore, scenarios like buybacks can impact the share premium account. For instance, if a company repurchases its shares at a price lower than the original issuance price, the difference is debited from the additional paid-in capital.
In terms of the broader context of shareholders' equity, the share premium or additional paid-in capital, alongside retained earnings, often forms the major components. Retained earnings represent accumulated profits not distributed as dividends and are utilized for debt repayment, reinvestment in the business, research and development, or other capital acquisitions.
Additional accounts that might appear within the shareholders' equity section include accumulated other comprehensive income, treasury stock, and unearned compensation, each playing a distinct role in reflecting the financial health and position of the company.
To illustrate, consider a scenario where a company issues shares at a nominal par value of $0.01 per share but raises $15 per share during an offering. The difference, $14.99 per share, constitutes the share premium or additional paid-in capital. This amount is recorded in the respective accounts, demonstrating the excess amount paid by investors over the par value.
In essence, a comprehensive understanding of the share premium account's role within shareholders' equity involves grasping its origins, impacts on financial statements, limitations on usage, and its broader implications in evaluating a company's financial standing and investor relations.
