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 a face value of $3 per share at the price of $5 per share, then the share premium reserve is $2 per share. Still, 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.
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For eg:
Source: Shares Premium (wallstreetmojo.com)
Also, note that the 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, the face value and the issue price of the share don’t need to be 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 into 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 sharesBonus SharesBonus 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 existing shareholders of the company.
- To write off the company’s preliminary expenses or underwriting cost.
- To write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more 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 shares and other type of securities.
Share Premium Reserve Formula
(Issue price per share – Face value/par value per share) * No of shares
OR
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 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 surplusReserves And SurplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet.read more of equity and liabilities.
Advantages
#1 – No Dilution in Rights
Raising funds additionally by 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 the form of 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 the 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 taxWithholding TaxWithholding tax is a part of the salary an employer withholds from an employee's compensation and pays to the legal authorities. It is treated as collateral imposed against the taxes an employee is liable to pay during a particular year.read more.
#3 – Timing of distribution
These premiums are eligible for the distribution to shareholders at any time. In contrast, the profits are not as profits can be distributed after the approval of financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more by shareholders in the general assembly.
#4 – Financial consideration
For the company, like reserves, This premium also represents an element of equity. For shareholders of the company, It provides extra value for their participation in the company.
#5 – Reduction in Cost
When the shares are issued at the premium, then the incidental advantage is the reduction in the cost of capital. 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, the rate of dividends to the shareholderShareholderA 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 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 only be utilized for the purpose as allowed in the corporate bylaws. For example, the company cannot pay dividendsDividendsDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more from the 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 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 Retained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more 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.
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