What Is Shares Premium?
Share Premium is the difference between the issue price and 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. 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 shares, 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 company’s securities premium of $3 is not gained. Simply it is the gain to the investor.
Share Premium Explained
Share premium is the amount which any company gets after issuing shares to investors and that is over and above the face value of the issued share capital. It is received when the shares are issued for the first time.
The par value is the lowest price at which the shares can be issued to the general public. But premium is the amount of money that the investors are ready to pay willingly pay to the company beyond the nominal value of the issued shares.
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’sretained 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.
The business can use this premium for various purposes, financing day-to-day operations, investing in growth and expansion, or new projects.
However, decision on how the share premium account will be used depends of the rules and by laws followed by the company’s management. It may have some restrictions and regulations which should be followed.
Also, note that the Share Premium account is also known as Additional Paid-in CapitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market. in US GAAP.
Let us not understand the 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 is known as the face value of shares. All the benefits given to the shareholders are decided to consider the face value of shares. For example, if the rate of dividend declaredDividend DeclaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. by the company is 10%. Then the 10% will be calculated using the face value of shares issued.
Let us look at the share premium formula that is used to calculate the premium on shares issued.
(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
Using this formula it is possible to calculate the premium on the shares that are issued to the investors.
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 premium using the share premium formula 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 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. of equity and liabilities.
The share premium account or the share premium capital 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. 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. 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 debenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer. or preference shares of the companyPreference Shares Of The CompanyA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation..
- To purchase its shares and other type of securities.
Let us go through the advantages of share premium in accounting.
#1 – No Dilution in Rights
Raising funds additionally using a 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 company’s balance sheet. Thus there will be no tax consequences by raising additional funds in the form of a 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..
#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. 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. will be high.
There are some disadvantages of share premium in accounting. The securities premium account is considered 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 dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. from the premium account. This account can be mainly used to offset the share issue expenses and not the operating losses.
This article has been a guide to what is Shares Premium. We explain its formula along with examples, uses, components, advantages and disadvantages.. You may learn more about accounting from the following articles –