What Is Paid-In Capital?
Paid-in capital is the total amount of cash that a company has received in exchange for its common or preferred stock issues. In a company balance sheet, paid-in capital will appear in a line item listed under shareholders' equity (or stockholders' equity). It is often shown alongside a line item for additional paid-in capital (also known as the contributed surplus).
The figure for paid-in capital will include the par value of the shares plus amounts paid in excess of par value.
Paid-in capital represents the money raised by the business through selling its equity rather than from ongoing business operations.
Key Takeaways
- Paid-in capital is the full amount of cash or other assets that shareholders have paid a company in exchange for shares of its stock. It includes both par value and the excess of par that was paid in.
- Additional paid-in capital refers to only the amount paid in excess of a stock's par value.
- Paid-in capital is reported in the shareholders' equity section of the balance sheet.
- It is usually split into two different line items: common stock (par value) and additional paid-in capital.
- Paid-in capital can be a significant source of capital for new projects and can help offset business losses.
Understanding Paid-In Capital
For sales of common stock, paid-in capital, also referred to as contributed capital, consists of a stock's par value plus any amount paid in excess of par value. In contrast, additional paid-in capital refers only to the amount of capital in excess of par value, or the premium paid by investors in return for the shares issued to them.
In modern times, most common shares are assigned token par values of a few pennies. Because of this, "additional paid-in capital" tends to be essentially representative of the total paid-in capital figure and is sometimes shown by itself on the balance sheet. (Preferred shares sometimes have par values that are more than marginal.)
Significance of Paid-In Capital
Additional paid-in capital can provide a significant part of a young company's resources before earnings start accumulating through multiple profitable years. It is an important layer of defense against potential business losses if retained earnings show a deficit.
Short of the retirement of shares, the account balance of paid-in capital—specifically, the total par value and the amount of additional paid-in capital—should remain unchanged as a company carries on its business.
Types of Stock Affecting Paid-In Capital
The balance sheet number on paid-in capital may reflect transactions in common shares, preferred shares, treasury stock, or some combination of all of these.
Common Stock
Paid-in capital is not a day-to-day revenue stream for a public company, and its value does not fluctuate.
When a public company wants to raise money, it may issue a round of common stock shares. It sells all of those shares to the public at par plus whatever value the market puts on it. From then on, the shares fluctuate in value as sellers and buyers determine their value in the open market.
A company certainly has a great interest in its stock price from day to day, but not because its balance sheet is immediately affected for better or worse.
Preferred Stock
A preferred stock issue is another way for a company to raise cash for its business. This hybrid of a stock and a bond appeals to investors who want a steady dividend payment and protection of their capital from bankruptcy.
Investors value preferred stock shares for their steady returns, not for their price growth, which can be minimal. They appeal to fewer investors, which is why most companies have relatively few shares of preferred stock than common stock in circulation.
Treasury Stock
Companies may buy back shares from time to time in order to reduce the total number of their shares in circulation. This is a popular move among shareholders, who are likely to see their shares increase in value.
The shares bought back are listed within the shareholders' equity section at their repurchase price as treasury stock, a contra-equity account that reduces the total balance of shareholders' equity.
If the treasury stock is sold at above its repurchase price, the gain is credited to an account called "paid-in capital from treasury stock." If the treasury stock is sold below its repurchase price, the loss reduces the company's retained earnings. If the treasury stock is sold at a price equal to its repurchase price, the removal of the treasury stock simply restores shareholders' equity to its pre-buyback level.
Paid-In Capital From Retirement of Treasury Stock
Companies may opt to remove treasury stock by retiring some treasury shares rather than reissuing them. The retirement of treasury stock reduces the balance of paid-in capital, applicable to the number of retired treasury shares.
If the initial repurchase price of the treasury stock was lower than the amount of paid-in capital related to the number of shares retired, then "paid-in capital from the retirement of treasury stock" is credited. If the initial repurchase price of the treasury stock was higher than the amount of paid-in capital related to the number of shares retired, then the loss reduces the company's retained earnings.
Once treasury shares are retired, they are canceled and cannot be reissued.
Example of Paid-In Capital
To illustrate, say Company B issues 2,000 shares of common stock with a par value of $2 per share. The market price per share is $20 per share. Paid-in capital is the total amount paid by investors for common or preferred stock. Therefore, the total paid-in capital is $40,000 ($4,000 par value of the shares + $36,000 amount of additional capital in excess of par).
In the shareholders' equity section of Company B's balance sheet, $36,000 is recorded next to the line item "Paid-in Capital in Excess of Par," while $4,000 is recorded next to the line item "Common Stock." The figures combined equal the total paid-in capital.
Paid-In Capital vs. Additional Paid-In Capital vs. Earned Capital
Each of these line items in a balance sheet convey a different piece of information to the interested investor or analyst:
- Paid-In Capital is the amount of money that investors have paid for shares in the company.
- Additional Paid-In Capital is the difference between the par value of the shares and the actual price of the shares. This reflects only shares bought directly from the company rather than on the stock market.
- Earned Capital is the amount of money that has been generated by the company's business operations.
A young company with big expectations might have significantly more paid-in capital than earned capital. This shows a degree of enthusiasm from investors.
A mature company should have more earned capital than paid-in capital. Earned capital is an indication of the amount of money that a company is actually taking in for its goods and services.
How Is Paid-In Capital Calculated?
Paid-in capital is the total amount received by a company from the issuance of common or preferred stock. It is calculated by adding the par value of the issued shares with the amounts received in excess of the shares' par value.
How Is Paid-In Capital Recorded?
Paid-in capital is recorded on the company's balance sheet under the shareholders' equity section. It can be called out as its own line item, listed as an item next to Additional Paid-in Capital, or determined by adding the totals from the common or preferred stock and the additional paid-in capital lines. Paid-up share capital is also listed in the shareholders' equity section. Paid-up share capital is money that the company has already received in payment of any sold shares.
Is Paid-In Capital a Debit or a Credit?
Paid-in capital appears as a credit (that is, an increase) to the paid-in capital section of the balance sheet, and as a debit, or increase, to cash.
If not distinguished as its own line item, there will be a debit to cash for the total amount received and credits to common or preferred stock and additional paid-in capital.
What Is the Difference Between Common Stock and Paid-In Capital?
Common stock is a component of paid-in capital, which is the total amount received from investors for stock.
On the balance sheet, the par value of outstanding shares is recorded to common stock, and the excess (that is, the amount the market price adds to par value) is recorded to additional paid-in capital.
The sum of common stock and additional paid-in capital represents the paid-in capital.
The Bottom Line
Paid-in capital may not be a headline number for a company, but it's worth taking note of it as an investor.
This number indicates the total amount of money that individual investors and institutional investors have staked on a company's success.
