What Is a Share Premium Account?
A share premium account is typically listed on a company’s balance sheet. This account is credited for money paid, or promised to be paid, by a shareholder for a share, but only when the shareholder pays more than the cost of a share.
This account can be used to write off equity-related expenses, such as underwriting costs, and may also be used to issue bonus shares.
- A share premium account is credited for money paid, or promised to be paid, by a shareholder for a share, but only when they pay more than the cost of a share.
- Share premium can be thought of as the difference between the par value of a company’s shares and the total amount of money a company receives for shares recently issued.
- This account can be used to write off equity-related expenses, such as underwriting costs, and may also be used to issue bonus shares.
Share Premium Account
Understanding Share Premium Account
Share premium can be thought of as the difference between the par value of a company’s shares and the total amount a company received for shares recently issued. For example, Company ABC has issued 300 shares of its stock. The shares are given a par value or are valued at $10 each; however, the company has been paid $15 per share.
Thus, the company has $4,500 in equity capital. Of this $4,500, only $3,000 is share capital. The remaining $1,500 is share premium, representing funds generated from shareholders as a return for their partial ownership of the company. The $1,500 appears on company’s balance sheet in the share premium account.
Share Premium Account Ebb and Flow
Over a period of time, the balance of the share premium account increases and decreases. This is because it is standard operating practice for a company to issue new shares that fall in line with the shares' current market value instead of shares’ arbitrary par value.
Continuing with Company ABC from the example above, over a two-year period, it suffers downswings in the market and is paid $6 per share on 100 new shares issued in the first six months of the two-year time period. This is a $4 discount per share to par value, and thus subtracts $400 from the share premium account, leaving it at $1,100. However, in the later portion of the two-year period, the company experiences a surge in the market. It issues 400 new shares with a par value of $20 per share. Shareholders pay $35 per share, adding $6,000 to the share premium account, leaving the account’s balance at more than $7,100.
Uses for Share Premium Accounts
The share premium account is a reserve that cannot be distributed. A company can use the balance of the account only for purposes that have been established in its bylaws. In most cases, a company cannot use the account to pay out dividends to shareholders or to offset operating losses. The share premium account is usually utilized to pay off equity expenses, which include underwriter fees. The account can also be used in the issuance of bonus shares and for costs or expenses related to this issuance.
Accounting for a Share Premium Account
A share premium account is recorded in the shareholders’ equity portion of the balance sheet. The share premium account represents the difference between the par value of the shares issued and the subscription or issue price. Share premium account may also be known as additional paid-in capital and can also be called paid-in capital in excess of par value. This account is a statutory and non-distributable reserve account.
Share premium can be money received for the sale of either common or preferred stock. A balance is recorded in this account only when there's a direct share sale from the company, usually from a capital raise or initial public offering (IPO). Secondary trading—between investors—does not impact the share premium account.
Where Does Share Premium Appear on a Company's Financial Statements?
Share premium is a component of shareholders' equity, which appears on the balance sheet.
Have Shares Always Been Issued at a Premium to Par?
No. Nineteenth-century initial public offerings were always issued at par. Historically, only issues from around the 1920s gave rise to any share premium and this was seen as a contribution by new shareholders to the accumulated retained profits belonging to the original shareholders who had initially invested in company assets and fueled its growth.
Why Did the Share Premium Arise?
The modern manner of issuing shares with small nominal (par) values and large share premiums was developed as a tax avoidance strategy in the 1920s. This loophole was eventually closed in 1973, but the capital structure has remained unchanged.