What Is Capital Surplus? Definition and How It Can Be Created

What Is Capital Surplus?

Capital surplus, or share premium, most commonly refers to the surplus resulting after common stock is sold for more than its par value. Capital surplus includes equity or net worth otherwise not classifiable as capital stock or retained earnings.

In the past, the account Paid-in Capital in Excess of Par - Common Stock and the account Premium on Common Stock were referred to as capital surplus. Most balance sheets today call capital surplus paid-in surplus or paid-in capital [in excess of par].

Understanding Capital Surplus

Five ways capital surplus can be created include:

1. From stock issued at a premium to par or stated value (most common)
2. From the proceeds of stock bought back and then resold
3. From a reduction of par or stated value or reclassification of capital stock
4. From donated stock
5. From the acquisition of companies that have capital surpluses

Although item 1 is the most common, items 2 and 5 should not be overlooked.

During the last decade, public companies have repurchased significant amounts of their common stock through share repurchase programs. In the future, to raise capital, these businesses could reissue treasury stock.

An uptick in M&A could also see more companies adjusting their balance sheets to account for capital surplus related accounting issues.

Capital stock can serve as an umbrella term for more specific classifications, such as acquired surplus, additional paid-in-capital, donated surplus, or reevaluation surplus (which could pop up during appraisals).

Capital Surplus vs. Retained Earnings

Although capital surplus and retained earnings are components of stockholders' equity and share similar characteristics, they are fundamentally different. Retained earnings are a company's earnings or profits remaining after it pays dividends to its shareholders. These profits are retained by the company and are often used to help the organization scale, such as expanding operations or diversifying a product line.

An organization's final retained earnings balance, which can be negative or positive, is calculated by adding its profits or losses to the beginning retained earnings balance and then subtracting dividends paid to shareholders. Retained earnings are reported in a category of the same name in the stockholders' equity section of the balance sheet.

Capital surplus does not represent earnings and results most commonly when investors pay more than par value for shares. If shares sell at their par value, there is no capital surplus. Capital surplus figures are reported in a category of the same name or titled "additional paid-in capital" in the stockholders' equity section of the balance sheet.

Capital Surplus Example

Consider the example in which a company sells 1000 shares of its common stock for $100 per share, totaling $100,000 in proceeds (1000 shares x $100). The common stock par value is $20 per share (total common stock proceeds = $20,000). Therefore, the capital surplus or additional paid-in capital is $80,000 ($100,000 - $20,000). Twenty thousand dollars will be recorded in the Common Stock account of the balance sheet and $80,000 recorded in the Additional Paid-In Capital account of the balance sheet.