Table Of Contents
Example
Let us consider a simple example to understand this concept better:
Say Mr. Frank is running a restaurant with four more shareholders. Mr. Frank wants to issue an additional 2,500 shares of $10 par stock to new investors to raise additional capital for expansionary projects. As the restaurant is performing exceptionally well, and the investors recognize future potential, the investors are willing to pay $30 for every share. In this case, the difference of $20 is the premium amount on the stock.
Accounting
The accounting for the stock premium is quite simple. The common stock account is used for recording the par value of the stock issued, and a separate account termed āpaid-in capital over parā is used to record the premium. This is an equity account representing the number of money investors have contributed to the firm in addition to the stock's par value. The journal entries for the same can be written as follows by extending the above example with a necessary explanation:
If additional stock is issued at a premium, the stock issuance is recorded by debiting cash for $75,000 ; crediting common stock for $25,000 . Further crediting the balance of $50,000 i.e. paid-in capital in excess of base value of $25,000. One can observe that common stock is only for recording the par value of the newly issued shares. Additionally, the paid-in capital account records the entire premium the new investors are willing to pay for the shares.
The entries have a different recording treatment when the securities premium amount is received with Application money and Allotment money.
If the premium money is received with application money, itās not credited directly to the Securities Premium Account. The application is received, but as there are possibilities of rejection, one must wait until the application is accepted and finalized. The entries would be:
There will also be times when the stock premium is collected with the allotment money. The journal entries would be:
Further, upon transfer of application money, the entry would be
An important point to be noted here is that if any advance amount was received during the application, such money should be adjusted towards the share allotment account. However, firstly the advance money should be adjusted against the nominal value of shares, and if any balance remains, it shall be adjusted against the securities premium account.
The account is listed on the equity section of the balance sheet and just below the common stock account.
- Every firm should strictly note that the stock premium is a non-distributable reserve. It can be used exclusively for a purpose as defined in the company's by-laws. It cannot be considered for any other purpose.
- Stock premium should be used for paying equity-related expenses such as Underwriterās fees.
- Firms are not permitted to utilize the share premium for the dividend payment to shareholders or for setting off operating losses.
- It could also be used for bonus issues to the stakeholders. The costs and expenses associated with issuing new shares can also be adjusted from the share premium.
Let us look at an extensive example with its impact on both the Journal and the Balance Sheet:
Andy Chemicals Ltd. had an authorized capital of $10,00,000 divided into 1,00,000 shares of $10 each. They issued 35,000 shares to the directors and 50,000 shares to the general public at a premium of $1 per share. Subscriptions were received completely, and these shares were allotted.
Frequently Asked Questions (FAQs)
In IPOs, the premium can indicate market demand and investor perception of the company's value. A higher premium might signify strong investor interest, while a lower premium could suggest cautious sentiment.
Yes, the premium on stock can change based on market conditions, company performance, industry trends, and investor sentiment. It may increase or decrease as these factors evolve.
A higher premium can result in a higher cost of equity for a company, as investors would expect higher returns to justify the premium paid for the stock.
The premium might remain relatively constant during a stock split as the par value is adjusted. In a reverse split, where several shares are consolidated into one, the premium may increase due to the reduction in outstanding shares.
Recommended Articles
This article has been a guide to what is Premium on Stock. Here, we explain the concept with an example, accounting process, and securities premium account. You can learn more about accounting from the following articles ā