Paid in Capital Meaning
The amount received by the company in exchange for the stock sold in the primary market i.e. stock sold directly to the investors by the issuer and not in the secondary market where investors sell their stock to other investors is called paid-in capital and can have both common and preferred stock.
Paid in capital is the part of the subscribed share capital for which the consideration in cash or otherwise has been received. It is a part of Shareholders’ Equity in the balance sheet which shows the number of funds that the stockholders have invested through the purchase of stock in the company. The amount shown in the balance sheet is the aggregate amount invested by all the investors, not by the particular investor.
Paid in Capital Calculation = Common Stock + Additional Paid-in Capital
As we note from above, Starbucks’ common stock is $1.3 million and Additional Paid-in Capital was $41.1 million in FY2018.
Therefore, Starbuck’s total Paid in Capital = $42.4 million
When the shares are directly purchased by the investor from the company then the company receives the fund as contributed capital and when the buyers buy the shares from the open market then the amount of shares is directly received by the investor selling them. Paid in share capital is not an income generated by the company through its day to day operations but actually, it is a fund raised by the company through the selling of its equity shares.
- It is the capital which is paid in during the preferred stock or common stock issuance by the investor. The shareholders are considered the owner of the company. Their money is invested in terms of share capital and in return, they get dividends (share of profit in the company)
- The shares issued by the company always have par value which is fixed when the shares are originally issued by the company in an IPO (initial public offer). It is the original cost of stock shown in the certificate. Market value is different from par value. Market value is determined by the buying and selling the business in the open market. In the balance sheet, the shares are always shown at their par value or face value.
- There are mainly two components of the paid-in share capital. The first one is the stated capital which is reported in the balance sheet at the par (face) value and the other is additionally paid-in the capital which amounts to the money received by the company above its par value. Additional paid-in capital calculation many times reflects the significant part of the shareholders’ equity before the retained earnings Start to accumulate and it is a safe layer in case the retained earnings is a deficit.
Examples of Paid in Capital Calculation
Let’s take an example where a company named XYZ Ltd. Issues shares worth $20 million having a face value of $20 per share. The shares are issued by the company at $30 per share which shows that $10 is the premium on issue of shares. Now the amount received is $600 million. This is bifurcated as
- Common Stock = $400 million ($20 million *$20)
- Paid-in capital Calculation = $200 million ($20 million *10)
- Additional share capital can be shown as the contributed surplus or can be reported differently under the head shareholders’ equity.
Business activities that affect the amount of Paid in capital
source: Starbucks SEC Filings
#1 -Issuance of shares
At the time of incorporation of company promoters and investors purchase the shares of the company. Firstly, the authorized share capital is fixed by the company beyond which the company cannot issue the shares in the market. The par value or the face value of each share is fixed by the company. So initially in the balance sheet, the issued and paid in capital is recorded at the par value. Afterward, if a company wants to raise funds by issuing more share capital in case there is any requirement of funds for any capital expenditure or other large business transactions then more share capital will be issued by the company and the amount will be paid up by the investors. After the amount has been paid by the investor, a new journal entry will be passed by recording the increase in the paid-in capital of the company. Stock prices in the secondary market don’t affect the amount of paid-in capital calculation in the balance sheet.
#2 – Bonus Shares
A bonus issue means an issue of free additional shares to the existing shareholders of the company. Bonus shares can be issued out of free reserves, securities premium account or capital redemption reserve account. Now with the issuance of bonus shares, the amount in the paid-in capital is increased and the free reserves are decreased. Although it doesn’t affect the total shareholders’ equity it will affect the paid in capital calculations and free reserves individually.
#3 – Buyback of shares
The buyback of shares by the company also affects the paid-in capital of the company. The shares bought back by the company are shown in the shareholders’ equity at the cost at which they are purchased in the name of treasury stock. If the company sells the treasury stock above the purchase cost then the profit from the sale of treasury stock is credited in paid in capital calculation from treasury stock under the head shareholders equity. If the company sells the share at a price below its purchase cost then the loss from the sale of treasury shares is deducted from the Retained earnings of the company and if the company sells the treasury stock at the purchase cost only then the shareholders’ equity will be restored to its pre-share-buyback level.
#4- The Retirement of treasury stock
The retirement of treasury stock is also an option for the company if the company doesn’t want to reissue it. Due to the retirement of treasury stock either the whole balance applicable to the number of retired shares in the paid-in capital get reduced or the balance from the paid-in the capital calculation at par value along with the balance in additional share capital get reduced accordingly depending upon the number of treasury shares retired.
#5 – Issuance of preferred shares
Sometimes management prefers to issue different classes of preferred shares instead of the common stock because of the expected negative reaction from the market by the company if it issues the share as that issuance may lead to the dilution of the value of equity. This will increase the total balance of paid-in capital calculation as the issuance of the new preferred shares will lead to an increase in the paid-in capital as excess value is being recorded.
This has been a guide on what is Paid in Capital and its meaning. Here we look at how to calculate Paid-in capital along with practical examples and activities that can change paid in capital. You can learn more about from the Accounting following articles –
- Definition of Share Classes
- Reverse Stock Split | Meaning
- Premium on Common Stock | Example
- Simple Example of Redeemable Preference Shares
- Examples of Depreciation Journal Entry
- Stock Splits Definition
- Non-Cumulative Preference Shares Definition
- Participating Preferred Stock Definition
- Outstanding Shares Definition