Shares Issued at a Premium

Shares Issued at a Premium Premium Par Value Issue Price Shares Share Premium Account
A share issued at a price above its par value is referred to as being issued at a premium. The premium is the difference between the issue price and the par value of the share.
On this page

Understanding Shares Issued at a Premium

When a company issues shares to investors at a price higher than their nominal or par value, these shares are described as being issued at a premium. The premium is the excess amount over the par value. It is an essential concept in corporate finance and has specific accounting treatments and implications for the company’s financial statements.

Detailed Definition

Shares Issued at a Premium refers to shares that are sold by a company for more than their par (or nominal) value. The par value is the minimum price at which shares can be issued, and it is typically a very small amount. The premium is the amount by which the issue price exceeds the par value. This premium is usually recorded in a share premium account (also known as additional paid-in capital) and cannot be used as freely as other reserves.

Example: If a company issues shares with a par value of $10 at an issue price of $15 per share, the premium per share is $5.

Accounting Treatment

  1. Par Value Portion: Recorded in the common stock account.
  2. Premium Portion: Credited to the share premium account.

Examples

  1. Example 1: Company ABC issues 1,000 shares with a par value of $1 each at $5 per share.

    • Par Value Portion: $1,000 (1,000 shares * $1 par value)
    • Premium Portion: $4,000 ((5-1) * 1,000 shares)

    Journal Entry:

    • Debit Cash: $5,000
    • Credit Share Capital: $1,000
    • Credit Share Premium Account: $4,000

  2. Example 2: Company XYZ issues 500 shares with a par value of $2 each at $7 per share.

    • Par Value Portion: $1,000 (500 shares * $2 par value)
    • Premium Portion: $2,500 ((7-2) * 500 shares)

    Journal Entry:

    • Debit Cash: $3,500
    • Credit Share Capital: $1,000
    • Credit Share Premium Account: $2,500

Frequently Asked Questions

Q1: Why do companies issue shares at a premium?

  • A1: Companies issue shares at a premium to raise more capital than the nominal value of the shares and reflect the actual value perceived by investors based on the company’s potential.

Q2: What happens to the share premium?

  • A2: The share premium is credited to the share premium account and can be used for purposes specified by the law, such as issuing bonus shares or writing off preliminary expenses.

Q3: Can a company use the premium to pay dividends?

  • A3: Typically, no. The premium cannot be used for dividend payments unless specifically allowed by the law.

Q4: Is issuing shares at a premium good for a company?

  • A4: Yes, it reflects investor confidence in the company’s future potential and allows the company to raise more funds than it would by selling shares at par value.
  • Issue Price: The price at which shares are offered to investors.
  • Par Value: The nominal value of a share, as stated in the corporate charter.
  • Share Premium Account: A reserve account holding the premium (excess over par value) received from issuing shares.
  • Share Premium: The amount above the par value for which shares are issued.

Online References

  1. Investopedia - Stock Issue
  2. Wikipedia - Share Premium
  3. The Balance - What Are Shares Premium?
  4. Corporate Finance Institute - Share Premium

Suggested Books for Further Studies

  1. “Financial Accounting” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
  2. “Accounting for Dummies” by John A. Tracy
  3. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
  4. “Financial Statement Analysis and Security Valuation” by Stephen H. Penman

Accounting Basics: Shares Issued at a Premium Fundamentals Quiz

### What is the term for the excess amount received over the par value of shares? - [ ] Par Value - [ ] Discount - [x] Premium - [ ] Dividend > **Explanation:** The term used for the excess amount received over the par value of shares is called "premium." ### Where is the premium on issued shares recorded in the company’s financial statements? - [ ] Dividend account - [x] Share premium account - [ ] Revenue account - [ ] Liability account > **Explanation:** The premium on issued shares is recorded in the share premium account, which forms part of the equity reserves. ### If a share’s par value is $1 and its issue price is $5, what is the premium per share? - [ ] $1 - [ ] $4 - [ ] $5 - [x] $4 > **Explanation:** The premium per share is calculated by subtracting the par value from the issue price: $5 (issue price) - $1 (par value) = $4 premium per share. ### Why might a company issue shares at a premium? - [x] To raise more capital than the nominal value of the shares - [ ] To distribute profits as dividends - [ ] To decrease the market value of shares - [ ] To pay off liabilities > **Explanation:** Companies issue shares at a premium to raise more capital than the nominal value of the shares, reflecting the market perception of the company's value. ### Can a company use the share premium account to pay dividends directly? - [ ] Yes, always - [x] No, unless legally allowed - [ ] Yes, only for ordinary shares - [ ] Yes, only for preference shares > **Explanation:** Generally, the share premium account cannot be used to pay dividends directly unless there are specific legal provisions allowing it. ### Which of the following is true regarding the issue of shares at a premium? - [ ] The premium portion affects the liabilities of the company. - [ ] The par value portion is recorded in the revenue account. - [x] The premium portion is recorded as part of equity in the share premium account. - [ ] The issue price is always less than par value. > **Explanation:** The premium portion, being the excess over par value, is recorded as part of equity in the share premium account. ### How should a company record the issue of shares worth $1,000 at a premium of $2,000? - [x] Debit Cash $3,000, Credit Share Capital $1,000, Credit Share Premium Account $2,000 - [ ] Debit Cash $3,000, Debit Share Premium Account $2,000, Credit Share Capital $1,000 - [ ] Debit Share Capital $3,000, Credit Cash $3,000 - [ ] Debit Share Premium Account $3,000, Credit Cash $3,000 > **Explanation:** The entry should show the total cash received, the par value portion credited to share capital, and the premium portion credited to the share premium account. ### Is the issuance of shares at a premium a common practice for companies with a strong market presence? - [x] Yes - [ ] No > **Explanation:** Yes, companies with a strong market presence often issue shares at a premium due to high investor confidence and market value. ### Which account cannot typically be used as freely as other reserves within a company after shares are issued at a premium? - [ ] Common Stock Account - [x] Share Premium Account - [ ] Dividends Payable - [ ] Retained Earnings > **Explanation:** The share premium account is restricted and cannot be used as freely as other reserves, adhering to regulations governing its use. ### What constitutes the fundamental difference between the issue price and the par value of a share? - [x] Premium - [ ] Discount - [ ] Retained Earnings - [ ] Revenue > **Explanation:** The fundamental difference between the issue price and the par value of a share is known as the premium.

Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!

Tuesday, August 6, 2024
Shares of Beneficial Interest
Shares Issued at a Discount
Premium January 1, 1
Capital Surplus January 1, 1
Minimum Premium Value January 1, 1
Nominal Value January 1, 1
Shares Issued at a Discount January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.