Accounting for Paid-In Capital: Calculation, Example, And Importance

The Paid-In capital or the Contribution capital represents the shareholders’ investment in a company through cash or assets. It forms a significant portion of the Shareholders’ total equity along with Retained Earnings. It comprises two parts of the Paid-In capital at Par value plus the Additional Paid-In capital above the par value of the share.

Paid-In capital can be raised through issuing common stocks or preferred stocks. Common stocks are issued at the above par value. Any funds raised through contributed capital become non-payable by the company to the investors and recorded at the book value.

The funds raised above the par value of the share are separately recorded as Additional Paid-In capital or Share premium.

Calculation:

The simple calculation for Paid-In capital can be performed by adding the share issued at nominal par value plus the additional reserve as share premium.

Paid-In Capital or contributed Capital = Total Stocks + additional Paid-In Capital

The Stocks can be split into common stocks or preferred stocks further if the preferred stocks issued have a significant amount. These stocks are recorded at face value. The issue price above par yields surplus cash, which is recorded as Share Premium or Additional Paid-in capital.

Companies issue new shares to raise funds when retained earnings or debt finance resources dry up. Shares are issued at face value denominating the Paid-In capital value.

However, the significant portion of funds comes through the higher issue price that the management receives as share premium. Although, the share premium has restricted utilization covenants but can be used for share issue expenses.

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Share capital reserves can be used for any company project expansion or investment purposes. The cost of Share Capital is usually higher for the company than debt financing.

Working Example:

Let’s suppose a company Green Star issued 1.5 million new shares at a par value of \$1.00. The issue price remained \$15 per share. Assume the Share issue was fully subscribed by the investors.

The simple Accounting Entry will be:

Effect of Bonus Issue or Buyback on Paid-In Capital:

If the company issues any bonus shares, the total shareholder’s equity remains unaffected. However, the retained earnings or reserves decrease, and the contributed capital or Share Premium increases.

With a Split stock, the company also keeps the cash or retained earnings, so the number of outstanding shares changes but the total equity remains unaffected for the shareholders.

With a share buyback program, the company may incur profits or losses or net proceeds. As the company pays back the investors for their invested amounts, the share capital amounts decrease. Often the buyback is performed when a company has large surplus cash or retained reserves.

Continuing with our example, if the company now buys back 0.5 million shares at the same price of \$15 per share, then:

The company buying back shares normally list under the Treasury stocks line. Any losses or gains due to a change in the share price are reflected against retained earnings or a reserve account usually called paid-in capital for treasury stocks.

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Any new shares issued either as common stocks or preferred will change the Paid-In capital the same way as for the first time. The accounting treatment on the balance sheet will also be the same, except that preferred shares are noted in a spate line on Equity’s section.

Another scenario can be to fully retire the bonus shares issued or treasury stocks. In that case, the amount of cancelled share will reduce the treasury stock balance. Any losses resulting from treasury stock cancellations are carried forward to the retained earnings account.

For significant gains through treasury stock cancellations, a separate reserve account can be used. The gains can also be noted under the retained earnings or other comprehensive income of the company accounts.

Important Considerations:

Contributed capital or paid-In capital relates to the shares issued at primary market through an IPO or preference shares. The accounting books will only reflect the share issued and subscribed by investors at par value. The additional capital through higher issue price is recorded separately as additional paid-in capital.

Any sales and purchases of common stocks at stock exchange do not reflect a change in the paid-in capital for the company. However, if the company issues preference shares, dividends in-kind, or bonus shares then the accounts books will record changes.