Why shares are issued at a premium
/A company issues its shares at a premium when the price at which it sells the shares is higher than their par value. This is quite common, since the par value is typically set at a minimal value, such as $0.01 per share. The amount of the premium is the difference between the par value and the selling price. If shares do not have a par value, then there is no premium. In this case, the entire amount paid is recorded in the common stock account (if the payment is for common stock, rather than for some form of preferred stock). For example, if ABC Company sells a share of common stock to an investor for $10, and the stock has a par value of $0.01, then it has issued the share at a premium of $9.99.
This premium is rarely recorded in an account having that name. Instead, it is more commonly recorded in an account called Paid-In Capital In Excess of Par Value. It may also be recorded in an account called Additional Paid-In Capital. Other than the use of two accounts to record the separate elements of the price at which a share is sold, there is no particular relevance to the concept of a premium.
Presentation of Shares Issued at a Premium
The additional paid-in capital account appears in the shareholders' equity section of the balance sheet. It does not appear in the income statement. This line item is highlighted in the following exhibit of a balance sheet.
Reasons for Issuing Shares at a Premium
Here are several reasons for issuing shares at a premium, including the following:
Strong market perception. Companies with a positive reputation, strong financial performance, or high growth potential can issue shares at a premium because investors are willing to pay more than the face value for the opportunity to own a part of a successful business.
Reflecting intrinsic value. A premium reflects the intrinsic value of the company, especially if its assets, brand, or intellectual property significantly exceed the book value, attracting investors willing to pay more based on future earning potential.
Avoiding undervaluation. Issuing shares at par or a discount may signal financial weakness or undervaluation. A premium issue, on the other hand, demonstrates confidence in the company’s prospects, reassuring investors about its growth trajectory.
Meeting regulatory requirements. In some jurisdictions, regulatory frameworks restrict issuing shares at a discount but allow premiums, making it a viable option for companies needing to comply with legal requirements while raising funds.
These reasons highlight how issuing shares at a premium can strengthen a company’s financial position while aligning with investor expectations.
Terms Similar to Share Issuance at a Premium
Share issuance at a premium is also known as capital surplus.