Paid-in Capital

What Is Paid-In Capital?

The sum amount that organizations get from investors in exchange for their stock is known as paid-in capital. This is a crucial element of a company's overall equity. Either preferred stock or common stock may be used as paid-in capital. 

Paid-in capital does not include earnings from continuing business operations; it only includes money earned from the sale of stock. 

If a company decides to repurchase shares from its owners, the balance in paid-in capital may be reduced; this can either be done directly in the account or recorded in a contra-equity account linked with and offset from the paid-in capital account.

The terms paid-in capital and additional paid-in capital have many differences. This is because the former refers to both the par value of the stock and the additional capital. 

This is the price at which the stock is sold above par value. The formula for paid-in capital is as follows:

Paid-in capital = Par value + Additional paid-in capital

An alternate interpretation is that additional capital paid equals already paid, excluding par value from the definition. So, when discussing paid-in capital with others who might have a different understanding of the phrase, you need to be clear on the definition.

The money will only be received through the issuer's direct sale of shares to potential investors. They are not derived from any operating activities or the sale of stock on the secondary market to other investors.

How Paid in Capital Works? 

Businesses issue new shares of common and preferred stock to raise paid-in capital. They can lower it by repurchasing their shares, which is known as treasury stock.

When a company is made, several states mandate that common stock be issued for the first time at par value; however, some states do not. All subsequent stock issuances are then included in the three paid-in capital accounts.

1. Common Stock 

Stock that is exchanged in the equity markets is known as common stock. The owner of common stock is entitled to vote and if awarded, dividends. 

An initial public offering (IPO) is the standard method businesses use to launch their common stock on the market. The business may decide to conduct a secondary public offering after the stock has been listed to raise more funds.

2. Preferred Stock 

In addition to being comparable to common stock, preferred stock is also comparable to fixed-income securities like bonds.

Priority payment in the event of bankruptcy is given to preferred stockholders, who also receive dividends before common stockholders do. Due to the absence of voting rights, preferred stock often has a lower potential for capital appreciation than common stock.

3. Treasury Stock 

All of the company's stock that has been acquired again is referred to as treasury stock. Remember that common and preferred stocks are stated at their initial values and are only adjusted for new issuances. 

The counter asset account used to account for repurchases is Treasury stock. 

Companies buy back stock for various reasons, including boosting earnings per share, undervaluing stock, and returning value to shareholders.

Effect of Bonus Issue or Buyback on Paid-In Capital

If the corporation issues any bonus shares, it does not affect the total shareholder equity. However, the contributed capital or Share Premium rises while retained earnings or reserves decline.

The overall equity for the shareholders is unaltered even when the number of outstanding shares changes with a split stock because the corporation also keeps the cash or retained earnings.

A share repurchase program could result in gains, losses, or net proceeds for the corporation. The share capital levels diminish when the corporation reimburses the investors for their invested amounts. 

The corporation that is repurchasing shares typically trades on the Treasury stocks line. Retained earnings or a reserve account, typically called paid-in capital for treasury stocks, offsetting any losses or gains resulting from a change in the share price.

The buyback is frequently carried out when a corporation has significant financial reserves or surplus funds.

The Paid-In capital will change the same way each time new shares are issued, whether they are common or preferred stock. Except for preferred shares being indicated in a single line on the Equity section, the accounting treatment on the balance sheet will remain the same.

Another possibility is to retire any issued bonus shares or treasury stocks completely. The canceled shares will then lower the remaining amount of Treasury Stock. Treasury stock cancellation losses are passed on to the retained earnings account going ahead.

A separate reserve account may be utilized for sizable gains from cancellations of treasury stock. The company's reports may also include the gains under other comprehensive income or retained earnings.

Additional Paid in Capital

A business can raise capital through both stock and debt finance. Share capital and premium are the units of measure for shareholders' equity. 

Common stock or share capital represents the resources put up by shareholders. A stock's overall value or market capitalization evolves through share price fluctuations.

The sum received above the par value of the shares is only referred to as the "share premium" or "Additional Paid-In Capital." It adds to overall shareholders' equity along with contributed or share capital. Both preferred and regular stocks are included in the share premium.

The difference between the par value and the excess amount received on shares sold during an IPO determines additional paid-in capital.

Recall that a stock's par value is typically shown on its certificates as a modest number, such as $0.10 or $0.01. The par value may occasionally be even less than $0.01. It is important to distinguish between the par value and the share's market value. 

The minimum price at which a firm may sell its shares to investors is known as par value. On the other hand, market activity dictates how much a share is worth on the open market.

The equation for additional paid-in capital is as follows: 

(Share Issue Price - Par Value) x (No. of Outstanding Shares) = Additional Paid-In Capital

Accounting for Additional Paid in Capital

On the assets side, cash offsets the balance sheet entry for the paid-in capital. There will be two portions to the liabilities section of the shareholders' Equity section. 

The sum raised equals the Par value plus any Additional Paid-In Capital over the Par Value.

Accounts Affected By Paid-In Capital

Account	Debit	Credit
Total Cash Proceeds	Cash
Amount at Par Value		Share Capital- Common Stock
Amount above Par Value		Additional Paid-In Capital

A working example will help us comprehend the balance sheet entries for the increased share premium.

Let's say Blue Star Co. issues 2 million shares with a $1.00 par value. The corporation fixes the issue price at $45. 

The subscriptions for shares were given to the corporation in three different transactions. In the following days, the first Share issued proceeds were 1.5 million, 0.3 million, and 0.2 million shares.

The cash, Share Capital (common stocks or preference stocks), and Additional Paid-In capital will typically alter as a result of an IPO transaction.

One definition of generalized accounting treatment is:

• Debit the full amount of the share sale profits from the Cash account on the balance sheet.
• Value at Par or Face value will be credited to the Share Capital account. 
• Credit the Share Premium Account over the Par Value or the Additional Paid-In Capital

Changes to the balance sheet:

Changes to the general ledger: 

 

Changes To The Additional Paid-In Capital

Any future modifications made on stock exchanges due to shareholders selling shares are not reflected in the share premium or Additional Paid-In Capital account. However, the Income Statement can account for any expenses or costs related to the share issue.

Dividend payments may not be made from Additional Paid-In Capital. Instead, the money might be used for commission or underwriting costs associated with issuing shares.

Moreover, any additional share-issued-related costs, such as treasury stock or compensation stock costs, are reported in the Company's income statement.

Dividends that are given in the form of stock rather than cash could result in yet another significant adjustment to the shareholders' share premium and overall equity. However, there is no accounting impact on the Additional Paid-In capital section with a cash dividend. 

However, retained earnings, share capital, and new capital would all be impacted if the corporation paid dividends via bonus stocks.

Let's continue with our example regarding the effects of dividend stock change. Let's say Blue Star distributes a 5% bonus stock to its 2.0 million shareholders as a dividend.

The market price is $45.0, and the Par value is $1.0. There will be 100,000 bonus shares issued or 2.0 x 5%. Therefore, $4,500,000 was the total share price issued.

The benefit for shareholders, however, is that they have an option; they can either keep the bonus stocks for capital gains or immediately sell them on the stock market to profit from dividends.

Reviewed and edited by Mohammad Sharjeel Khan | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Additional Paid-In Capital
• Additional Paid-In Capital Vs. Contributed Capital
• Share Capital
• Shareholders’ Equity
• Stock-Based Compensation