Companies can raise funds mainly through two forms, debt, and equity. Equity financing is a company’s prime liability towards its shareholders.
Companies often issue additional shares with initial public offerings or rights issues to raise funds. Additional Paid-in capital or Share Premium refers to the money shareholders pay above the face value of the company stocks.
All company stocks are listed first at Par or Face value of the shares. However, the stock market determines the actual market value of the issued shares.
Demand-Supply of the company stocks plays a key role in deriving stock market price. Although, a company’s stocks will be valued higher if investors see potential gains with investment.
A company’s total equity can be mainly calculated with contributed capital (paid-in or paid-up) and additional paid-in capital (also called Share Premium).
When investors incorporate a company to start a business, the paid-up capital is recorded at book value. However, companies often need additional cash for several business purposes including debt and project management.
When a company issues new shares in the primary market (stock exchange) or directly with a rights issue, they nominate the shares at Par or Face value. Any additional amount that investors pay above the Par value is calculated as Additional Paid-in capital.
It can be calculated as,
Additional Paid-In Capital = (Share Issue Price – Share Par Value) × No. Of Shares Issued
Note here, there are only three components required for the simple calculation.
- Share Par Value: It is the nominal legal value of a company’s stock that is approved for issuing and recording share price in the financial books. It is usually a fraction of a dollar or up to $ 1.
- Share Issue Price: A company management’s decided price to issue new shares through an IPO. It is always above the nominal par value and closely linked with the current Stock Price of the company.
- Shares Issued: A company may issue any number of shares in an IPO but within the limit of authorized capital. Authorized capital is the maximum number of shares allowed by the Security and Exchange Commission to raise funds.
Suppose a company Techno Blue wants to raise additional funds through an IPO. It has a nominal Par value of shares listed at $0.50. It issued 2 million new shares at an issue price of $35. Suppose the company has been able to sell all the shares and raise the required funds it intended.
Additional Paid-In Capital = (35 – 0.50) × 2,000,000 = $ 69,000,000
The total Share Equity with the IPO becomes $ 7 million. The contributed share capital here will be $ 100,000 and Additional Paid-In capital will be $6.9 million.
Accounting for Additional Paid-In Capital:
Like contributed share capital, it is the shareholders’ equity. It is recorded on the Balance sheet under the Equity section. Usually, it is denominated after the share capital and before the Retained Earnings section.
Continuing with our example, the accounting entry to record the transaction will be as:
|Share Capital- Common Stock||$100,000|
|Additional Paid-In Capital||$6,900,000|
Any Expenses related to the IPO or change in values is recorded subsequently in the Income Statement. Any Expenses incurred are offset on the income statement against the retained earnings and reduce the shareholders’ equity.
Important Considerations for Additional Paid-In Capital:
Two components make up for the additional capital amount. The Par value is a nominal book price of the shares a company can decide within its disclosed financial statements.
Secondly, only the Issue price of the shares is important for the Additional Paid-In capital account. Once the Shares are sold at the stock market through an IPO, the market value of the shares may change over time.
Any subsequent sales on the stock market among stockholders do not impact the Share Premium or Additional Paid-In capital account.
Continuing with our example, if the company performs well, its share prices may appreciate in value, say to $50. The stockholder’s selling shares at $50 can make profits of $15 per share.
The converse for losses is also true. Any changes after the IPO transactions do not reflect changes on the Share premium account as the transactions are among shareholders, not the company.
A company’s share capital or equity makes up for its stock’s par value and additional paid-in capital. Additional Paid-In capital is the amount the company raises through an IPO only. Any changes in share prices after the IPO do not affect the share premium or additional capital account.