Shares Premium

What is Shares Premium Account?

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.read more 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 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.read more in US GAAP.

Components of Share Premium Account

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 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.read more 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:

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
share premium

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.

This article has been a guide to what is Shares Premium Account and its definition. Here we discuss how to calculate share premium reserve formula and its calculations along with practical examples and uses. You may learn more about accounting from the following articles –

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