Finance plays a crucial role in shaping businesses, and understanding the nuances of financial structures can be the key to making informed investment decisions. One of the most overlooked yet significant concepts in corporate finance is share premium. It represents the extra value investors are willing to pay over and above the nominal or par value of shares. I will explore this concept in detail, covering its calculation, accounting treatment, and implications.
Table of Contents
What Is Share Premium?
Share premium arises when a company issues shares at a price higher than their nominal value. This excess amount is recorded in a separate account known as the share premium account. This account is part of shareholders’ equity but distinct from share capital.
For instance, if a company issues 1,000 shares with a nominal value of $10 per share but sells them at $15 per share, the share premium per share is $5. The total share premium collected is:
\text{Total Share Premium} = (\text{Issue Price} - \text{Nominal Value}) \times \text{Number of Shares}Substituting the values:
\text{Total Share Premium} = (15 - 10) \times 1000 = 5000The company records $10,000 in share capital and $5,000 in the share premium account.
Why Does Share Premium Matter?
Understanding share premium is essential because it reflects investor confidence in a company. When investors pay more than the nominal value, it signals that they perceive the company as valuable. Share premium also plays a role in corporate finance as it can be used for specific purposes, such as issuing bonus shares or writing off preliminary expenses.
Accounting Treatment of Share Premium
The share premium amount is credited to the share premium account under the equity section of the balance sheet. The journal entry for share issuance at a premium is:
| Account Name | Debit ($) | Credit ($) |
|---|---|---|
| Cash/Bank Account | 15,000 | |
| Share Capital | 10,000 | |
| Share Premium A/C | 5,000 |
This structure ensures that the share premium amount is accounted for separately from share capital.
Legal Restrictions on Share Premium Usage
Companies cannot use share premium freely. According to corporate laws, it can only be utilized for:
- Issuing fully paid bonus shares
- Writing off preliminary expenses
- Writing off underwriting commissions
- Providing for premium payable on redemption of preference shares
Using share premium for dividend payments or normal operating expenses is typically restricted by law.
Comparison of Share Capital and Share Premium
| Feature | Share Capital | Share Premium |
|---|---|---|
| Definition | The nominal value of issued shares | The excess amount over nominal value |
| Accounting Treatment | Credited to share capital account | Credited to share premium account |
| Usage | General corporate purposes | Restricted to specific financial activities |
| Reflection on Equity | Forms part of base capital | Indicates investor confidence |
Example: Real-World Share Premium Calculation
Consider a tech startup, Innovate Inc., that issues 50,000 shares with a nominal value of $2 per share at an issue price of $5 per share.
\text{Total Share Premium} = (\text{Issue Price} - \text{Nominal Value}) \times \text{Number of Shares} \text{Total Share Premium} = (5 - 2) \times 50000 = 150000The company records $100,000 in share capital and $150,000 in the share premium account.
Impact of Share Premium on Investors
Investors analyze share premium to assess the market perception of a company. If a company consistently issues shares at a premium, it suggests strong investor demand. However, an abnormally high premium may indicate speculative trading rather than intrinsic value.
Share Premium in the U.S. Market
In the U.S., companies record share premium under additional paid-in capital (APIC). The concept remains the same, but U.S. GAAP does not impose strict legal restrictions on its use, unlike some other countries.
Conclusion
Share premium represents the additional value investors assign to a company’s shares beyond their nominal value. It serves as a crucial indicator of investor confidence and plays a role in corporate finance. Understanding share premium helps in making informed financial decisions, whether as an investor or a corporate finance professional.
