What Is Share Premium Account?
A share premium account is a non-distributable reserve on a company's balance sheet that records the amount of money received from issuing shares above their nominal value, also known as par value. It falls under the broader category of corporate finance and accounting. When a company issues shares, the par value is a minimum legal price, often a very small amount. Any excess cash or consideration received over this par value for newly issued shares is recorded in the share premium account. This account is not a separate bank account but rather an internal accounting entry within a company's equity section.26
The share premium account forms part of a company's total equity and represents a part of the capital contributed by stockholders that is not considered part of the legal share capital. It's a crucial component of a company's financial structure, reflecting capital raised beyond the legal minimum.
History and Origin
The concept of a share premium account emerged as a way to account for funds received by companies when issuing shares for more than their nominal value. Historically, the purpose of setting aside this premium was primarily to protect creditors and ensure that a company retained sufficient capital. Many jurisdictions, such as the United Kingdom with its Companies Act, have specific provisions for how share premium accounts must be managed. For instance, the Companies Act 2006 in the UK stipulates that any premiums on shares must be transferred to a separate share premium account and cannot be treated as distributable profit for general purposes like paying dividends.24, 25 This legal framework ensures that the capital base of the company remains strong, safeguarding creditor interests and maintaining investor trust.23 International accounting standards, such as IAS 32 "Financial Instruments: Presentation" under the International Financial Reporting Standards (IFRS), also provide guidance on the presentation and classification of amounts like share premium, ensuring consistency in financial reporting globally.22
Key Takeaways
- A share premium account records the excess amount received when a company issues shares above their par value.21
- It is a non-distributable reserve, meaning it generally cannot be used to pay dividends to shareholders.20
- The account is part of a company's total equity on the balance sheet.19
- Funds in the share premium account can be used for specific purposes, such as issuing bonus shares or offsetting expenses related to the share issue.17, 18
Formula and Calculation
The calculation of the share premium is straightforward: it is the difference between the issue price of a share and its par value.
To find the total amount in the share premium account from an issuance, you multiply the share premium per share by the number of shares issued:
For example, if a company issues common stock with a par value of \($1.00\) at an issue price of \($10.00\), the share premium per share is \($9.00\). If 1,000,000 shares are issued, the total share premium account would be \($9,000,000\).
Interpreting the Share Premium Account
The share premium account provides insight into how a company has raised its capital beyond its basic share capital. A substantial share premium indicates that a company has successfully issued shares at prices significantly higher than their nominal value, which can reflect positive market perception, strong demand for its shares, or a high valuation. This reserve is important for understanding a company's capitalization structure.
From an accounting perspective, the share premium account is generally considered a capital reserve. Unlike retained earnings, which represent accumulated profits available for distribution as dividends, the share premium account is restricted. Its primary purpose is to protect the company's capital base, which is beneficial for creditors and overall financial stability. Analysts often review the share premium account as part of the overall stockholders' equity to assess the strength and composition of a company's equity base.
Hypothetical Example
Imagine "GreenTech Innovations Ltd." is a new company that decides to raise capital by issuing shares.
- Par Value: GreenTech sets the par value of its shares at \($0.10\) per share. This is the minimum legal value.
- Issue Price: Due to strong investor interest and the company's promising technology, GreenTech is able to issue 5,000,000 shares to the public at \($5.00\) per share.
- Calculation:
- The amount received per share above the par value is \($5.00 - $0.10 = $4.90\). This \($4.90\) is the share premium per share.
- The total amount transferred to the share capital account (representing the par value) would be \(5,000,000 \times $0.10 = $500,000\).
- The total amount transferred to the share premium account would be \(5,000,000 \times $4.90 = $24,500,000\).
On GreenTech's balance sheet, under the equity section, the share capital would be \($500,000\), and the share premium account would show \($24,500,000\). This demonstrates how the share premium account captures the significant portion of capital raised through the issuing shares that exceeds the nominal value.
Practical Applications
The share premium account has several practical applications in corporate finance and accounting:
- Capital Protection: It acts as a non-distributable reserve, which helps protect the company's long-term capital base. This is crucial for maintaining solvency and protecting the interests of creditors.16
- Funding Share Issue Expenses: In many jurisdictions, the share premium account can be used to write off expenses directly related to the issuance of shares, such as legal fees, underwriting commissions, and printing costs.15 This allows the company to absorb these costs without impacting its distributable profits.
- Issuing Bonus Shares: Companies can use the share premium account to issue fully paid bonus shares (also known as scrip dividends or capitalization issues) to existing members.14 This allows the company to reward shareholders by increasing their number of shares without distributing cash, thereby retaining profits within the business. This is particularly relevant for public limited companies seeking to increase their issued share capital.
- Mergers and Acquisitions (M&A): In certain mergers and acquisitions scenarios, particularly those involving share-for-share exchanges, specific rules (e.g., "merger relief" in some jurisdictions) may impact how share premium is accounted for. This can facilitate business combinations without unnecessarily inflating share premium accounts.
- Compliance with Regulatory Bodies: For publicly traded companies, the treatment and disclosure of the share premium account are subject to scrutiny by regulatory bodies like the U.S. Securities and Exchange Commission (SEC). The SEC's Division of Corporation Finance reviews company filings to ensure compliance with disclosure and accounting requirements, including those related to equity and capital accounts.13 Similarly, adherence to standards set by bodies like the Financial Accounting Standards Board (FASB) in the U.S.12 or International Financial Reporting Standards (IFRS) globally11 is essential for accurate financial reporting.
Limitations and Criticisms
While the share premium account serves important functions, it also has limitations and can sometimes be a source of complexity:
- Non-Distributable Nature: The most significant limitation is its general non-distributable nature. Funds in the share premium account typically cannot be used to pay out cash dividends to shareholders.10 This restriction is designed to protect a company's capital, but it means that funds recorded here are not readily available for general corporate purposes or direct shareholder returns in the same way retained earnings might be.
- Rigid Usage Rules: The specific uses for the share premium account are often legally defined and quite rigid. For instance, while it can be used for share issue expenses or bonus shares, it cannot be used for operational spending or general shareholder payouts without a formal capital reduction process, which can be complex and require court approval in some cases.8, 9
- Complexity in Capital Reductions: Reducing or canceling the share premium account to make funds distributable or to adjust capital often requires a formal capital reduction process, which can be time-consuming and expensive. This process typically involves legal steps, such as solvency statements from directors and special resolutions from shareholders, often needing approval from a supermajority of votes.7
- Jurisdictional Differences: The exact rules governing the share premium account can vary significantly between different legal jurisdictions. What is permissible in one country under its Companies Act might be treated differently under another's corporate law or accounting standards. This can create complexities for multinational corporations or investors dealing with companies across different regions.
- Impact on Book Value: While contributing to equity, the restricted nature of the share premium account means it's treated distinctly from other equity components like retained earnings, affecting how a company's book value is perceived and utilized for various financial analyses.
Share Premium Account vs. Retained Earnings
The share premium account and retained earnings are both crucial components of a company's stockholders' equity, yet they differ fundamentally in their origin and permissible uses.
Feature | Share Premium Account | Retained Earnings |
---|---|---|
Origin | Arises from the issuance of shares at a price above their par value. | Accumulates from a company's net profits over time, after dividends are paid. |
Distributability | Generally a non-distributable reserve; cannot be used for general cash dividends.6 | Represents accumulated profits that are typically available for distribution as dividends to shareholders. |
Purpose | Protects the company's capital base; can fund share issue expenses or bonus shares. | Funds future growth, debt repayment, share repurchases, or dividends. |
Nature of Reserve | Often considered a "capital reserve" with specific statutory uses. | Considered a "revenue reserve" or "distributable reserve." |
Impact on Equity | Increases the "paid-in capital" portion of equity beyond par value. | Increases equity through accumulated profits, reflecting operational success. |
While both contribute to the overall equity, the share premium account represents capital paid in by shareholders directly, beyond the legal minimum share capital. In contrast, retained earnings represent internally generated wealth from a company's operations. The distinction is vital for understanding a company's financial health, its capacity to distribute funds, and its adherence to accounting principles.
FAQs
What is the primary purpose of a share premium account?
The primary purpose of a share premium account is to record the excess amount received when a company issues shares for more than their par value. It serves as a capital reserve that helps protect the company's capital base and is generally non-distributable, meaning it cannot be used for general dividend payments.4, 5
Can a company use its share premium account to pay dividends?
No, generally, a company cannot use its share premium account to pay cash dividends.3 The funds in this account are typically considered a non-distributable capital reserve by law, designed to protect the company's core capital and creditors. However, it can be used for specific purposes like issuing fully paid bonus shares.2
Is the share premium account an asset?
No, the share premium account is not an asset. It is an equity account that appears on the liabilities side of the balance sheet, specifically within the stockholders' equity section. It represents a portion of the capital contributed by shareholders, distinguishing it from assets like cash or property.
What is the difference between share capital and share premium?
Share capital (or stated capital) represents the nominal or par value of the shares issued by a company. The share premium, on the other hand, is the amount received over and above this nominal or par value when shares are issued. Both are components of a company's total equity, but share capital reflects the legal minimum, while share premium reflects the market value premium paid by investors.1
How is the share premium account impacted by share buybacks?
The accounting treatment of share premium during share buybacks can be complex and depends on the specific jurisdiction and accounting standards. Generally, when a company repurchases its own shares, the accounting may involve reducing both the share capital and potentially the share premium account, or offsetting the cost against retained earnings, depending on the legal and accounting specifics of the buyback. This often falls under rules for capital reduction.