A company can raise funds through equity and debt financing. Shareholders’ equity is denominated by share capital and share premium. The common stock or share capital represents the resources invested by shareholders. Over time, the total valuation or market capitalization of stock changes through share price adjustments.
Share premium or Additional Paid-In capital only represents the amount received above the par value of the shares. It contributes to the total shareholders’ equity along with contributed or share capital. Share premium includes both common stocks and preferred stocks.
How to Calculate?
Additional Paid-In capital is simply calculated by the difference in the par value and excess amount received on shares sold through an IPO.
Additional Paid-In Capital= (Share Issue Price – Par Value) × No. Of Shares Outstanding
Account for the Additional Paid-In Capital:
The Balance sheet entry for the pad-in capital is adjusted against cash on the assets side. The liabilities portion under the Shareholders’ Equity section will be divided into two parts. The amount raised equal to the Par value + the Additional Paid-In capital above the par value.
|Total Cash Proceeds||Cash|
|Amount at Par Value||Share Capital- Common Stock|
|Amount above Par Value||Additional Paid-In Capital|
We can understand the balance sheet entries for the additional share premium through a working example.
Suppose the company Green Star Co. Issues 2 million shares at a par value of $1.00. The company sets the issue price at $ 45. The company received the share subscriptions in three different transactions. The first Share issued proceeds remained at 1.5 million shares, 0.3 million and 0.2 million shares on the following days.
Thus, the Journal entries can be recorded as the share sales proceeds on three different dates.
|First Transaction Date||Cash||$ 67.5 m|
|Share Capital- Common Stock||$1.5 m|
|Additional Paid-In Capital||$66.0 m|
|Second Transaction Date||Cash||$ 13.5 m|
|Share Capital- Common Stock||$ 0.3 m|
|Additional Paid-In Capital||$13.2 m|
|Third Transaction Date||Cash||$ 9.0 m|
|Share Capital- Common Stock||$ 0.2 m|
|Additional Paid-In Capital||$ 8.8 m|
|Total||$ 90.0 m||$ 90.0 m|
Balance Sheet Entry:
|Share Capital- Common Stock||$2,000,000|
|Additional Paid-In Capital||$88,000,000|
Generally, a transaction with IPO will result in a change in the cash, Share Capital (common stocks or preference stocks) and the Additional Paid-In capital.
Generalized Accounting Treatment can be termed as:
- Debit the Cash account on the Balance Sheet for the full share sale proceeds.
- Credit the Share Capital account with value at Par or Face value. And
- Credit the Additional Paid-In capital or the Share Premium Account above the Par Value
Changes to the Additional Paid-In Capital:
Share premium or Additional Paid-In Capital account does not reflect any subsequent changes made at stock markets through the sale of shares by shareholders. However, any expenses or costs associated with the share issue can be reflected in the Income Statement.
Additional Paid-In capital funds cannot be used for dividend payments. The funds can be used for share-issued expenses such as commission or underwriting expenses.
Also, any other share-issued related expenses such as treasury stock or compensation stock expenses are recorded in the Income statement of the Company.
Another significant change in Share Premium and total Shareholders’ equity may arise due to Dividends paid in the stock form rather than cash. With a cash dividend, there is no accounting effect on the Additional Paid-In capital section. However, if the company paid dividends through bonus stocks it affects retained earnings, share capital, and additional Paid-In capital.
Let’s continue with our example under the dividend stock change impacts.
Suppose Green Star Issues 5% bonus stocks as a dividend for its 2.0 million outstanding shares. The Par value is $1.0 and the market price at $45.0.
The bonus shares issued will be 2.0 × 5% = 100,000.
Total Share price issued= $ 4,500,000.
The Balance Sheet treatment can be recorded as below:
|Retained Earnings||$ 4,500,000|
|Share Capital- Common Stock||$100,000|
|Additional Paid-In Capital||$4,400,000|
Note: The Company may not have enough Retained Earnings in Cash form. That is the prime reason it issued the bonus stocks rather than cash dividends.
However, the advantage for shareholders is a two-way choice; they can hold the bonus stocks for capital gains, or immediately sell in the stock market to capitalize against dividends.