What is Premium on Common Stock?
A premium on stock highlights the amount of money investors is willing to pay in addition to the par value of the stock. It is an indication of the share value and the expectations from the market for the specific company. The firm should either be exceeding market expectations or keep investors interested in the future prospects of the company which makes them pay more than the par value of the share
Example of Premium on Stock
Let us consider a simple example. Say Mr. Frank is running a restaurant with 4 more shareholders. Mr. Frank wants to issue an additional 2,500 shares of $10 par stock to new investors for raising additional capital for expansionary projects. As the restaurant is performing exceptionally well and the investors recognize future potential, the investors are willing to pay $30 for every share. In this case, the difference of $20 is the premium amount on the stock.
Accounting for Stock Premium
The accounting for the stock premium is quite simple. The common stock account is utilized for recording the par value of the stock issued and separate account termed as ‘paid in capital in excess of par’ is used for recording the premium. This account is an equity account representing the number of money investors have contributed towards the firm in addition to the par value of the stock. The journal entries for the same can be written as follows by extending the above example with a necessary explanation:
If additional stock is issued at a premium, the stock issuance is recorded by debiting cash for $75,000 [2,500 shares *$10 par value], crediting common stock for $25,000 [2,500 shares * $10 par value] and further crediting the balance of $50,000 [$75,000 – $25,000] i.e. paid-in capital in excess of base value of $25,000. One can observe that common stock is only used for recording the par value of the newly issued shares. Additionally, the paid-in capital account records the entire premium the new investors are willing to pay for the shares.
The entries have a different recording treatment when the securities premium amount is received with Application money and also with Allotment money.
If the premium money is received with application money, it’s not credited directly to the Securities Premium Account. The application has been received but as there are possibilities of rejection, one needs to wait till the application is accepted and finalized. The entries would be:
There will also be times when the stock premium is collected with the allotment money. The journal entries would be:
Further, upon transfer of application money, the entry would be
An important point to be noted here is that in case any advance amount was received during the application, such money should be adjusted towards the share allotment account. However, firstly the advance money should be adjusted against the nominal value of shares and if any balance remains, it shall be adjusted against the securities premium account.
The account is listed on the equity section of the balance sheet and just below the common stock account.
- Every firm should strictly note that stock premium is a non-distributable reserve and can be used exclusively purposes as defined in the by-laws of the company. It cannot be considered for any other purpose.
- Stock premium should be used for paying equity related expenses such as Underwriter’s fees.
- Firms are not permitted to utilize the share premium for the dividend payment to shareholders or for setting off operating losses.
- It could also be used for bonus shares issuance to the stakeholders. The costs and expenses associated with the issuance of new shares can also be adjusted from the share premium.
Let us look at an extensive example with its impact on both the Journal and the Balance Sheet:
Andy Chemicals Ltd. was having an authorized capital of $10,00,000 divided into 1,00,000 shares of $10 each. They issued 35,000 shares to the directors and 50,000 shares to the general public at a premium of $1 per share. Subscriptions were received completely and these shares were allotted.
Securities Premium Account
This Stock premium account has been created for specific purposes and various laws across the state that this account should only be used for such specific purpose and no other activity.
The account is used for the following purposes:
- Issuance of fully paid-up bonus shares to the existing stakeholders. It should be noted that this cannot exceed the limit of the unissued shared capital of the firm.
- Writing of issue of shares and debentures e.g. commission paid or discount given on the issue of shares.
- Usage for the writing of any preliminary expenses of the company.
- The balance could also be used in providing premium payable on debenture redemption of preference share of the company.
- Buy-back of its own shares.
- It should not be used for dividend payment
This has been a guide to Premium on Stock. Here we discuss how to account for Stock Premium on Balance Sheet along with practical examples and explanation. You can learn more about accounting from the following articles –