When it comes to the amount of capital a company has, two main accounts show the total amount, paid-in capital and additional paid-in capital. While both of these represent the total capital of a company obtained from its shareholders, they are still different. To understand the difference, however, it is vital to understand what each of these accounts represents.
What is Paid-in Capital?
Understanding the paid-in capital of a company is straightforward. Paid-in capital, also known as share capital, is the account that represents the total capital of a company in the par value of shares issued. Par value of a share is its original price.
Companies must issue shares to their shareholders and other potential investors to obtain finance for their activities. All these shares have a predetermined par value.
The par value of a share is different from its market value. That is because the par value represents the value of the shares defined in the corporate charter.
The market value of a share, on the other hand, represents the value that market participants would be willing to pay for it. Its market value depends on several factors, such as the performance of the company in recent years and other external factors outside the control of the company.
Therefore, the paid-in capital balance in the accounts of a company represents only the par value of shares that it has issued. Paid-in capital does not take into account the market price of the share or how much the shareholder has paid for it, which is usually higher than the par value. Accounting standards require companies not to record any excess amount received for the issuance of shares in the paid-in capital account.
What is Additional Paid-in Capital?
As mentioned above, companies usually receive a higher amount for issuing new shares above the par value. Since they cannot record the amount in excess of par value in the paid-in capital account, they must record in another account, known as the additional paid-in capital account.
The additional paid-in capital account represents the equity of a company in excess of the par value of its issued shares. The amount of the capital in the account depends on the actual amount the company receives in exchange for issued shares.
Unlike the par value of a share, the actual price that the company will receive is not a part of the corporate charter. The price depends on its market price. However, the market price of the share isn’t the only deciding factor for its issue price, though.
The company issuing the shares has control over how much it charges. The higher the price, the more capital it will generate. However, higher prices may also attract lesser investors. Therefore, companies must decide on a price that investors will be willing to pay.
A company, ABC Co., issues 10,000 new shares. The shares have a par value of $1 per share. However, ABC Co. issues them for $5. It means that the total amount of capital that the company will receive for the issued shares is $50,000 (10,000 shares x $5 per share). However, the par value of the issued shares is only $10,000 (10,000 shares x $1 par value per share). The company must differentiate between how much to record in the paid-in and additional paid-in capital accounts.
Since the par value of the issued shares is $10,000, ABC Co. can record it in the paid-in capital account. In the additional paid-in capital account, ABC Co. must record $40,000. That is because it records $10,000 in the paid-in capital account, which represents the par value of the shares. Since ABC Co. received $50,000 for the total shares, the excess amount above par, $40,000, will be the additional paid-in capital.
The main difference between paid-in capital and additional paid-in capital is the amount recorded in each account. As mentioned above, paid-in capital only includes the par value of the issued shares of a company. Therefore, regardless of what its actual issue price is, a company must only record the par value in the paid-in capital account.
On the other hand, additional paid-in capital consists of capital that the company generates above the par value of the shares. As demonstrated in the example above, the additional paid-in capital account depends on the actual issue price of the shares.
The paid-in and additional paid-in capital accounts of a company represent its total equity generated through the issue of shares. While both the accounts are very similar and closely related to each other, there is a difference between the two.
Paid-in capital account represents the par value of the total issued shares of a company. On the other hand, additional paid-in capital account represents the excess amount above the par value of the shares that a company receives.