Shares Premium Account (Definition,Example)| What is Security Premium?

What is Shares Premium Account?

Share Premium is the difference between the issue price and the par value of the stock and is also known as securities premium. The shares are said to be issued at a premium when the issue price of the share is greater than its face value or par value. This premium is then credited to the share premium account of the company.

It arises when the company issues its shares for the first time to the public above its face value not when the investors sell them in the open market. For example, if the company sells its share having the face value of $3 per share at the price of $5 per share then the share premium reserve is $2 per share but if the investors sell the same further $8 per share then the securities premium of $3 is not gained by the company. Simply it is the gain to the investor.

Also, note that Share Premium account is also known as Additional Paid in Capital in US GAAP.

Components of Share Premium Account

#1 – Issue price of Share Capital

The price at which the company offers its shares to the public for sale is called an issued price. The shares can be issued at, above or below its face value. Therefore, it is not necessary that the face value and issue price of the share is the same.

#2 – The Face value of Share Capital

The initial value or the original value of the share decided when the capital was raised initially is known as the face value of shares. All the benefits given to the shareholders are decided to take in consideration the face value of shares. For example, if the rate of dividend declared by the company is 10%. Then the 10% will be calculated using the face value of shares issued.

Uses of Share Premium Account

The share premium account or the securities premium account cannot be distributed as dividends but can be used for the following reasons:

To issue the bonus shares to the existing shareholders of the company.
To write off the company’s preliminary expenses or underwriting cost
To write off the equity related expenses like discount allowed or commission paid on the issue of shares.
To provide for the premium payable at the time of redemption of debentures or preference shares of the company.
To purchase its own shares and another type of securities.

Share Premium Reserve Formula

(Issue price per share – Face value/par value per share) * No of shares

Total amount received on issue of shares – Total par value of shares issued

Example of Share Premium Account

For example, XYZ Company issued 500 shares at $15 per share having a par value of $10 per share.

Now the total amount received by the company is 500*$15 = $7500
Total face value of shares = 500*$10 = $5000

Total share premium reserve = $2,500

Another way to calculate the share premium can be:

The share premium per share = $15 – $10 = $5
So total share premium is $5*500 = $2500.

The above amount of $2500 will be credited to the securities premium account and will be reported under the head reserves and surplus of equity and liabilities.

Advantages

#1 – No Dilution in Rights

For raising the funds additionally by the means of share premium account does not lead to the dilution of the rights of the shareholders as the same number of shares are issued with the additional amount in form of share premium.

#2 – Tax Neutral

The company does not issue shares in exchange for any goods or services so there will be no profit or gain by this. Also, it is not the income for the company rather they are reflected in the equity head of the balance sheet of the company, thus there will be no tax consequences by raising additional funds in form of share premium account for the reason that it does not have any taxable base or tax burden. Also at the time of distribution of dividends to the shareholders, it is not considered so they are also not subject to the dividend withholding tax.

#3 – Timing of distribution

These premiums are eligible for the distribution to shareholders any time whereas the profits are not as profits can be distributed after the approval of financial statements by shareholders in the general assembly.

#4 – Financial consideration

For the company, like reserves, This premium also represents as an element of the equity. For shareholders of the company, It provides extra value for their participation in the company.

#5 – Reduction in Cost

When the shares are issues at the premium then the incidental advantage is the reduction in the cost of capital as it does not require any additional administrative work and no additional fees for the authorized capital and registrar of companies as the fees are paid on the authorized share capital amount.

#6 -Higher Dividend Rate

As the dividend is declared on the paid up share capital and not on the premium account so the rate of dividend to the shareholder will be high.

Disadvantages/Limitation

The account of securities premium considered as the restricted account as the amount received as the premium is not a part of free reserves. The amount of share premium account can be only utilized for the purpose as allowed in the corporate bylaws. For example, the company cannot pay dividends from the share premium account. This account can be mainly utilized to set off the share issue expenses and not the operating losses.

Conclusion

The amount received over and above the face value of the issued share capital is the share premium. It is received when the shares are issued for the first time. No share premium is received by the company when shares are further sold in the secondary market. The use of it is restricted to the purpose as specified in the corporate bylaws. It is a part of the company’s retained earnings but cannot be treated as the free reserve. Thus the amount of share premium reserve must be utilized as per the conditions of the law.

Shares Premium