What it means
Nominal values are largely a legal formality, often set at a cent or a pound when a company is formed and rarely changed afterwards. Because investors pay what the shares are actually worth, almost every issue after the first raises far more than nominal value, and accounting rules require the excess to be recorded separately.
The share premium account is where that excess lives. The split exists to protect creditors.
Share capital and share premium together form the company's non-distributable capital base, which cannot ordinarily be returned to shareholders without a formal process such as a court approved or director certified capital reduction. Retained earnings, by contrast, are distributable, which is why a company can be profitable on paper and still be restricted in what it can pay out.
There are limited uses for the balance beyond sitting there. In many jurisdictions the account may be applied to write off the costs of issuing the shares that created it, and to fund a bonus issue of fully paid shares to existing shareholders.
Both uses reduce the reserve without any cash leaving the business. Reading a balance sheet, the practical point is to add share capital and share premium together to see what shareholders have actually contributed.
A company showing share capital of $12,500 and share premium of $1,487,500 has raised $1,500,000 from shareholders, and looking only at the first figure gives a wildly misleading impression of how the business was funded. Terminology varies by country, which trips people up in cross-border discussions.
What is called a share premium account in the United Kingdom and much of Europe appears as additional paid-in capital or capital in excess of par in United States reporting, and some jurisdictions permit no par value shares in which case the whole issue price goes to a single stated capital account.
In practice
Real-world examples.
Example
A private company issues 10,000 shares of $1 nominal value to a new investor at $45 each. Share capital increases by $10,000 while the share premium account increases by $440,000, and the balance sheet shows both lines separately within equity.
Example
A listed company completes a placing and offsets the broker and legal fees of $620,000 against the share premium created by the issue. No expense reaches the profit and loss account, because the costs are treated as a deduction from the proceeds of raising equity.
Example
A mature business with a large share premium balance capitalises part of it to make a bonus issue of one new share for every five held. Shareholders receive more shares without paying anything, the reserve falls and share capital rises by the same amount, and nobody is any richer.
Formula
Calculation
Share premium = (issue price per share - nominal value per share) x number of shares issued
A company issues 250,000 ordinary shares with a nominal value of $0.05 each at an issue price of $6.00 per share, incurring $40,000 of professional and listing costs on the issue.
Premium per share = $6.00 - $0.05 = $5.95
Share premium = 250,000 x $5.95 = $1,487,500
Share capital = 250,000 x $0.05 = $12,500
Total cash raised = 250,000 x $6.00 = $1,500,000
Check: $12,500 + $1,487,500 = $1,500,000
Applying the $40,000 of issue costs against the reserve, as many jurisdictions permit, leaves a share premium balance of $1,487,500 - $40,000 = $1,447,500. The equity section then shows share capital of $12,500 and share premium of $1,447,500, and the arithmetic reconciles to the cash that reached the bank net of the costs of getting it there.Case study
Seen in the real world.
Merridale Brewing is an illustrative and entirely fictional regional brewer that raised money to build a canning line. It issued 250,000 ordinary shares of $0.05 nominal value at $6.00 each, bringing in 250,000 x $6.00 = $1,500,000, of which $12,500 went to share capital and $1,487,500 to the share premium account.
Issue costs of $40,000 were written off against the reserve under the rules applying in its jurisdiction, leaving a share premium balance of $1,447,500. Two years later, wanting to make its shares more accessible to a wider group of local investors, the board capitalised $500,000 of the reserve in a bonus issue of fully paid shares, reducing the share premium account to $947,500 and increasing share capital by the same $500,000.
The illustrative episode produced a useful internal correction. A junior board member had assumed the premium balance was surplus cash available for a special dividend, and the finance director had to explain that the reserve is a record of past contributions rather than a pot of money, and that it is not distributable in the ordinary way.
Watch out
Common mistakes.
- Treating the share premium account as spare cash. It is a reserve within equity describing where funding came from, not an asset, and the cash it represents was spent long ago.
- Reading share capital alone as the amount shareholders invested. The premium account usually holds the overwhelming majority of the money raised and has to be read alongside it.
- Assuming the reserve can be paid out as a dividend. It is generally non-distributable and can only be reduced through the specific routes local company law allows.
Questions
People also ask.
What is the difference between share capital and share premium?
Share capital records the nominal value of shares issued, while share premium records everything paid above that nominal value in the same issue.
What is share premium called in United States accounts?
It normally appears as additional paid-in capital or capital in excess of par, and it performs the same function under a different label.
Can the share premium account ever be reduced?
Yes, typically by writing off the costs of the share issue that created it, by funding a bonus issue of fully paid shares, or through a formal capital reduction with the required approvals.
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