What is a Share Premium Account in Accounting?

Share Premium Account Definition

Before we can explain what a share premium account is, we first need to understand some key terms related to shares and share capital.

 

When a company is formed, it may decide to raise funds by selling shares.

 

These shares represent ownership in the company.

 

Each share typically has a nominal value (sometimes called par value), which is the face value assigned to the share when the company is formed.

 

Typically, the par value is often very low.

 

As an example, it could be £1 per share.

 

A share premium occurs when a company issues shares at a price above their nominal value.

 

For example, if a company issues a share with a nominal value of £1, but sells it to investors for £5, the difference between the two is £4.

 

This £4 is the share premium.

 

Accounting wise, instead of recording the full sale amount (£5) as share capital, the company splits it into two parts:

 

  • The nominal value (£1) is recorded in the share capital account.
  • The excess amount (£4) is recorded in the share premium account.

 

Therefore, we can see that the share premium account is the account where the company records the extra money received over the nominal value of its shares.

Share Premium Account Importance

The share premium account exists to keep the company’s financial records accurate and to comply with legal regulations.

 

It ensures that the nominal value is clearly separated from the additional amount received over the nominal amount (the share premium).

 

Companies are often required by law to keep these two amounts separate because they serve different purposes.

Share Premium vs Retained Earnings

It’s easy to confuse a share premium account with retained earnings, but they serve different purposes in the financial statements:

Retained Earnings

These are the accumulated profits of a company that haven’t been distributed as dividends.

 

Retained earnings can be used for dividends, reinvestment, or any other business purpose without restrictions.

Share Premium

This is the excess amount received above the nominal value of issued shares.

 

It is a restricted reserve that legally cannot be used for dividends and can only be used for specific legal purposes (see below).

What Can the Share Premium Account Be Used For?

Common allowable uses of a share premium account include:

Issuing Bonus Shares

The share premium account can be used to issue bonus shares (also known as stock dividends) to existing shareholders.

 

This process converts the premium into share capital, increasing the shareholding value of existing shareholders without requiring them to pay for additional shares.

Costs Relating to Issuing Shares

When a company issues new shares, it often incurs expenses related to marketing, underwriting fees, or commissions to agents.

 

The share premium account can legally be used to cover these costs, which allows the company to avoid charging these expenses against its retained earnings or net profit.

Writing Off Preliminary Expenses

Companies can use the share premium to cover preliminary (startup) expenses, which include costs associated with setting up the business, like legal fees, incorporation fees, and other related expenses.

 

This allows the company to absorb initial costs without impacting profits.

Example of a Share Premium Account Transaction

Let’s look at a real world example to see how the share premium account works.

 

Imagine a company decides to issue 100,000 new shares to raise funds for expansion.

 

The nominal value of each share is £1, but due to high investor interest, the company is able to sell these shares at £5 each.

 

Here’s what happens in the company’s accounting records:

Nominal Value

£1 per share

Issue Price

£5 per share

Share Premium

£4 per share (£5 – £1)

For the 100,000 shares issued, the company receives a total of £500,000 (100,000 shares x £5).

 

However, the nominal share capital will only be £100,000 (100,000 shares x £1), while the share premium will be £400,000 (100,000 shares x £4).

 

So the company will record:

Share Capital

£100,000

Share Premium

£400,000

Example of a Share Premium Account Transaction

How is a Share Premium Account Shown on the Financial Statements?

On a company’s balance sheet, the share premium account is usually listed under the section called “equity” or “shareholders’ equity”.

 

Here’s how a simplified balance sheet might show it:

Balance Sheet

Amount (£)

Assets

 

Cash

100,000

Other Assets

200,000

Total Assets

300,000

Liabilities and Shareholders’ Equity

 

Liabilities

100,000

Share Capital (100,000 shares @ £1 each)

100,000

Share Premium Account (£4 per share)

400,000

Retained Earnings

100,000

Total Liabilities and Equity

300,000

In this example, the company issued 100,000 shares at £5 each.

 

The nominal value is £1 per share, so the total share capital is £100,000 (100,000 shares x £1).

 

The share premium is £4 per share, resulting in a share premium account balance of £400,000 (100,000 shares x £4).