Difference Between Share Capital and Share Premium

Key Difference – Share Capital vs Share Premium
 

Issue of shares is a very important decision to a company with the main objective of raising funds for expansion. Share Capital and Share Premium are major components of equity. The key difference between share capital and share premium is that while share capital is the equity generated through the issue of shares at face value, share premium is the value received for shares that exceed the face value.

CONTENTS

1. Overview and Key Difference
2. What is Share Capital
3. What is Share Premium
4. Side by Side Comparison – Share Capital vs Share Premium

What is Share Capital?

This is the equity component of the company received through selling ownership of shares to the public investors. Shares will usually be issued at ‘par value’ or ‘nominal value’  (face value of a security). Share capital will be reflected in the equity section of the Statement of Financial Position (Balance Sheet).

E.g. If 10,000 shares are issued at a par value of $2.5, the resulting share capital will be $25,000.

Share capital will be accounted for as,

Cash A/C                 Dr $25,000

Share capital A/C             Cr $25,000

Once the shares start to trade and the company’s performance improves, the share price will appreciate. Furthermore, a reduction in share price may also occur due to a negative action. Despite these movements, the value of the share capital remains at the initial sale value. ($ 25,000 in the above example)

There are two main categories of shares known as ordinary/common shares and preference shares. Ordinary shares are owned by the principal owners of the company, and these are all equity shares. Preference shares are also equity shares, however, may have fixed or floating dividend rates.

Preference shares

They can be,

Cumulative Preference Shares

Preference shareholders often receive cash dividends. If a dividend is not paid in one financial year due to low profits, then the dividend will be accumulated and is payable to the shareholders at a later date.

Noncumulative Preference Shares

These preference shares do not carry the opportunity to claim dividend payments at a later date.

Participatory Preference Shares

These types of preference shares carry an additional dividend if the company meets pre-determined performance goals in addition to the normal dividend payment.

What is Share Premium?

Share premium is the additional amount of funds received exceeding the par value of security. The ending balance of the Share Premium account is recorded in the Statement of Financial position after the Share Capital. Issuing shares at a premium is a commonly used practice as par value is often set at a minimum level and does not reflect the true worth of the company. Furthermore, some companies remain private for a significantly long period of time to be successfully established before going public, in which case the real value of such companies may have drastically evolved since incorporation.

Continuing from the above example,

e.g.: If the shares were issued at $ 3 instead of $ 2.5, the accounting entry would be,

Cash A/C                               Dr $ 30,000

Share capital A/C        Cr $ 25,000

Share premium A/C                    Cr $ 5,000

The funds in the Share Premium account can be utilized to make a bonus issue of shares to existing shareholders and for share repurchases. Share premium funds are also commonly used to cover underwriting expenses (paid to a financial institution, usually an investment bank that assists companies to introduce their new shares to the market) or other expenses related to issuing stock shares. These funds cannot be used to cover general expenses unrelated to share issues. Thus the account is not distributable.

What is the difference between Share Capital and Share Premium?

Reference:

“The Chase National Bank of the City of New York, Specimen Stock Certificate” By Downingsf – Own work (CC BY-SA 3.0) via Commons Wikimedia