Share Premium Account: Definition & Purpose | Financial Accounting

A share premium account is sometimes referred to as an additional paid-in account, and it is included in the shareholder’s equity section of a balance sheetBalance SheetThe balance sheet is one of the three fundamental financial statements. The financial statements are key to both financial modeling and accounting.. The share premium account records the amount received that is above the subscription price of a share.

Shares are considered to be issued at a premium if the amount received for issued shares is greater than the face value of shares. The premium is calculated by finding the difference between the share issue price and the par value of shares offered for sale.

Summary

• Share premium is the excess money received for issued shares above the par value.
• The share premium account is a reserve account whose funds can only be used for purposes provided in the corporate bylaws, such as for share issue costs or issuance of bonus shares, but cannot be used for dividends.
• It is recorded in the shareholder’s equity portion of a balance sheet.

Understanding Share Premium Accounts

Assume that ABC Company issued 1,000 shares of stock for subscription to the public. The company assigned the shares a par value of $10 each, expecting to raise a share capital of $10,000. Instead, the shareholders paid a premium price of $15 per share.

Therefore, the shareholders paid $15 for each share of stock, the company raised $15,000 in equity capital, out of which $10,000 is the share capital, and the remaining $5,000 is the share premium. Both the share capital and the share premium are recorded in the balance sheet under shareholder’s equity.

Components of a Share Premium Account

1. Issue Price

Issue price refers to the price at which a company offers its shares of stock when they become available to the public. A company can sell the shares at the stated issue price, at a discount, or at a premium of the face value.

2. Face Value

Face value is the price of shares when they are created for the market. For financial institutions, the par valuePar ValuePar Value is the nominal or face value of a bond, or stock, or coupon as indicated on a bond or stock certificate. It is a static value and face value are used to refer to the same thing. The face value, according to state laws, requires that companies not sell their shares below face value. It is the minimum price that each shareholder is expected to pay for each share of stock. Any benefits offered to shareholders consider the face value of shares.

How a Share Premium Account is Used

The balance of a share premium account is expected to change if the company offers new shares for subscription at the market price. As a reserve account, companies can only use the funds for purposes discussed in their bylaws or other legal documents.

For example, the company cannot distribute the funds in the account as dividends or use the balance to settle losses incurred by the business. Rather, companies may use the share premium account to offset expenses incurred when raising equity, such as underwriting fees, discounts allowed, commission paid on the issue of shares, etc.

The account can also be used to provide premiums payable on debenturesDebentureA Debenture is an unsecured debt or bonds that repay a specified amount of money plus interest to the bondholders at maturity. A debenture is a long-term debt instrument issued by corporations and governments to secure fresh funds or capital. Coupons or interest rates are offered as compensation to the lender. or to issue bonus shares to the company’s shareholders.

Accounting for Share Premium Account

The share premium is recorded every time the company offers shares for sale directly to the public, either to raise capital for a project or during an IPOInitial Public Offering (IPO)An Initial Public Offering (IPO) is the first sale of stocks issued by a company to the public. Prior to an IPO, a company is considered a private company, usually with a small number of investors (founders, friends, family, and business investors such as venture capitalists or angel investors). Learn what an IPO is. It is recorded in the balance sheet. However, trading between shareholders on an exchange, or privately does not affect the share premium account.

The share premium is one of the components of the shareholder’s equity section of a balance sheet. The other big component is retained earnings. Companies use the retained earnings to settle liabilities, finance a new acquisition, or fund research and development. The retained earnings may become a negative value if it has an accumulated net loss for all years of operation.

When listing items in the shareholder’s equity section of a balance sheet, the common stock account is listed first in the list, followed by the share premium account. Other items recorded in this section include treasury stockTreasury StockTreasury stock, or reacquired stock, is a portion of previously issued, outstanding shares of stock that a company repurchased from shareholders., earned compensation, and accumulated other comprehensive income.

Advantages of Share Premium Account

1. Does not dilute the rights of shareholders

Share premium is a method of raising additional funds for the company without diluting the voting rights of shareholders. It is a safer alternative to issuing additional shares to the public for subscription since it would reduce the percentage ownership of each shareholder.

2. Reduced cost of capital

When a company sells its shares at a premium, it does not incur additional costs for the administrative work involved. The additional capital raised in the form of a share premium does not attract additional fees beyond the fees incurred when raising the authorized share capital.

Limitation of Share Premium Account

Restricted usage

The share premium account is a reserve account whose funds cannot be used for just any purpose. Instead, the funds in the share premium account can only be utilized for the purposes provided in the company’s bylaws, such as paying equity-raising expenses, or underwriting fees.

More Resources

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In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Accumulated Other Comprehensive Income (AOCI)Accumulated Other Comprehensive Income (AOCI)Accumulated Other Comprehensive Income (AOCI) are special gains and losses that are listed as special items in the shareholder equity section
• Common StockCommon StockCommon stock is a type of security that represents ownership of equity in a company. There are other terms – such as common share, ordinary share, or voting share – that are equivalent to common stock.
• Earned IncomeEarned IncomeEarned Income is perceived as payment through an employer or one’s own business. It can include the following: wages, salaries, bonuses, tips
• Retained EarningsRetained EarningsThe Retained Earnings formula represents all accumulated net income netted by all dividends paid to shareholders. Retained Earnings are part