What is Additional Paid In Capital
Additional paid in capital represents the excess paid by an investor over and above the par-value price of a stock issue and is often included in the contributed surplus account in the shareholders' equity section of a company's balance sheet. Additional paid-in-capital can arise from issuing either preferred stock or common stock.
Additional Paid-In Capital
BREAKING DOWN Additional Paid In Capital
Equity and debt are both offered to investors as a financial product. Like other products, there's a cost of making the product, and the company makes money from selling the product for a profit. Additional paid in capital, also known as contributed capital in excess of par, is another way of referring to profit on common stock. It is the book value of profit from selling a share of stock over and above the cost of the share. The cost of the share is referred to as the par value. The par value for a share is printed on the stock certificate. Additional paid-in-capital is the amount investors have paid the company over and above par value.
It is important to note that additional paid-in-capital is only recorded at the initial public offering. The transactions that occur after the initial public offering do not increase the additional paid-in-capital account.
Additional Paid in Capital Example
Assume that a company issues 1 million shares with a par value of $50 per share. When the shares are purchased by investors, however, they pay $70 per share, a premium of $20 over par value. As the capital received from this issue is recorded, $50 million is allocated to a share capital or paid-in-capital account. The excess $20 million is allocated to the contributed surplus account as additional paid-in-capital. Some companies choose to separate additional paid-in-capital from contributed surplus on their balance sheets.
Par Value in Calculating Additional Paid in Capital
Par value is a tricky concept for students of accounting and finance; however, it is at the heart of the additional paid-in capital calculation. Par value represents the cost of a share of stock, but is an arbitrary number. In this way, additional paid-in-capital may be considered an arbitrary number and, therefore, somewhat meaningless. It is the equivalent of a company selling air, assigning an arbitrary cost to the air and then booking the difference as profit.
The par value is set when the company originally issues shares before there is a market. That said, it is not uncommon for the par value to be set at 1 cent per share. This is due to state laws, some of which restrict companies from selling shares below par value. Some states even allow companies to offer shares with no par value.