Capital surplus definition
/What is a Capital Surplus?
A capital surplus is the additional paid-in capital in excess of par value that an investor pays when buying shares from an issuing entity. This amount represents the difference between the market value of shares and their par value. The term is is no longer commonly used; instead, the concept is now called additional paid-in capital in the accounting literature.
Par value was originally the price at which a company's shares were initially offered for sale, so that prospective investors could be assured that the company would not issue shares at a price below the par value. However, par value is no longer required by some states; in other states, companies are allowed to set the par value at a minimal amount, such as $0.01 per share. The result is that nearly all of the price paid for a share of stock is recorded as additional paid-in capital (or capital surplus, to use the older term). If a company issues shares that have no stated par value at all, then there is no capital surplus; instead, the funds are recorded in the common stock account.
Capital Surplus vs. Retained Earnings
Capital surplus is not the same as retained earnings, which is the aggregate amount of profits retained by a business over time, minus any dividend payments made to shareholders. The key differences between the two concepts are as follows:
Source. A capital surplus is created when shares are sold to investors, while retained earnings are generated from company operations over time.
Subsequent use. A capital surplus is usually retained, since it is a primary form of equity funding. Conversely, retained earnings are more likely to be paid out to investors in the form of dividends or stock repurchases.
How to Generate a Capital Surplus
There are several ways in which a capital surplus can be generated. The most common approach is to sell stock above its par value. Another possibility is to reduce the par value of the stock, which reclassifies the excess par value into the capital surplus classification. It is also possible to generate a capital surplus from the resale of treasury stock.
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Example of a Capital Surplus
If ABC Company were to sell 100 shares of its $1 par value common stock for $9 per share, it would record $100 of the $900 in total proceeds in the Common Stock account and $800 in the Additional Paid-in Capital account. In earlier days, the $800 entry to the Additional Paid-In Capital account would instead have been made to the Capital Surplus account.
Thus, if the capital surplus term were still used, a company would acquire a capital surplus by selling its stock to investors at a price above the designated par value of the stock, with the incremental amount above the par value being identified as capital surplus.
Terms Similar to Capital Surplus
A capital surplus is also called additional paid-in capital or a share surplus.