Premium on Stock is defined as the amount of extra money which the investors of the company are ready to pay to the company for the purchase of the company’s stock over its par value and it calculated by subtracting the par value of the share issued from the issuing price.
What is Premium on Common Stock?
A premium on stock highlights the number of money investors are willing to pay in addition to the par value of the stockPar Value Of The StockPar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more. 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 prospects of the company, which makes them pay more than the par value of the sharePar Value Of The SharePar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more.
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Example of Premium on Stock
Let us consider a simple example. Say Mr. Frank is running a restaurant with 4 more shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more. 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 stockCommon StockCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity.read more account is utilized for recording the par value of the stock issued, and a separate account termed as ‘paid-in capital in excess of parPaid-in Capital In Excess Of ParPaid in Capital is the capital amount that a Company receives from investors in exchange for the stock sold in the primary market, including common or preferred stock. This considers the sale of stock that an issuer directly sells to the investor & not the sale of stock on the secondary market between investors. read more’ 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]. 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 the use of common stock is only 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 is received, but as there are possibilities of rejection, one needs to wait until 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 sharesThe Nominal Value Of SharesNominal Value of Shares refers to a stated value that the business issues to a specific type of share for balance sheet purposes. You can calculate it by, Nominal Value of Shares = Value of the total Paid-up Share Capital/Total No. of outstanding shares at a given point in timeread more, 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 the stock premium is a non-distributable reserve. It can be used exclusively for purpose 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 lossesOperating LossesThe term "net operating loss" refers to an operating loss that occurs when a company's expenses exceed its revenues in a given period and is reflected in the accounting books in the period when the company's allowable tax deductions exceed current taxable income.read more.
- It could also be used for bonus issuesBonus IssuesBonus shares refer to the stocks issued by the companies for free of cost to their existing shareholders in the proportion of their stock holdings. Companies issue such shares to compensate the shareholders with a higher dividend payout in the form of stocks.read more 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 a 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 sharesIssue Of SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more.
- 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 the preference share of the company.
- Buy-back of its shares.
- It should not be used for dividend payments.
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