Definition of Additional Paid-Up Capital on Balance Sheet
Additional paid-up capital is created when the share capital value exceeds the par value of the stocks. This is a phenomenon that only occurs at the time of issuance of new shares by the company, i.e. initial public offering (IPO), or in other words, when investors directly buy shares from the company. It cannot be created in the secondary market because buying and selling a company in the secondary market does not require the company to issue new shares and thus not impact the company’s share capital. In this topic, we are going to learn about Additional Paid-Up Capital on the Balance Sheet.
Explanation
Additional paid-up capital is also referred to as ‘contributed capital in excess par’ or ‘share premium’ and brings out the fact that how much more the investors have paid above the nominal value of the share of the company, i.e. the difference between the actual price of the share and its nominal value.
The nominal value of a share of the company is very small due to government mandates, and it is printed on the stock certificates. Par value of a share is the minimum price at which the company can sell the share to the investors; it is different from the market value, which is usually determined by the transactions happening in the market. It is recorded on the balance sheet under the stockholder’s equity section.
How to Create Additional Paid-in Capital on Balance Sheet?
Additional paid-in capital is created at the time of the initial public offering, that is, the first time a stock is issued in the primary market by the company. Additional paid-in capital is also impacted when the company repurchases its own stock.
At the time of the first-time issuance of the share or initial public offering (IPO), the company is free to fix any price for its stock subject to government norms, and investors can pay an amount above the par value of the stock. Any excess amount than the nominal or par value of the stock will create additional paid-in capital on the balance sheet.
Example of Additional Paid-In Capital on Balance Sheet
A company in its initial public offering (IPO) issues 2 million shares at the par value of $1 per share. The final sale of shares by the company to the investors confirmed the price value of $10 per share. Now the common stock and additional paid-in capital on the balance sheet will be calculated as follows:
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Solution:
Common stock = No. of shares × Par value per share = 2 million × $ 1 = $2 million
Total share capital = No. of shares × Final share price per share = 2 million × $10 = $20 million
Additional paid-in capital = Total share capital – Common stock value = $20 million – $ 2 million = $18 million
Therefore, the additional paid-in capital is $18 million ($20 million less par value of $2 million).
Importance of Additional Paid-In Capital on Balance Sheet
The importance of additional paid-in capital can be understood from the below points:
- A large portion of the company’s equity capital: Additional paid-in capital serves as a substantial amount of share capital before the retained earnings of the company start building up.
- A source of contingency funds: In the event of potential losses and insufficient retained earnings, the additional paid-in capital serves as a layer of defense against these losses.
- Fuel for the company: Share capital is fuel for the running of companies. Therefore, additional paid-in capital gives a start-up business a lot more flexibility in carrying out its operations.
Additional Paid-up Capital on Balance Sheet vs Contributed Capital
Additional paid-in capital is the excess value per share above its par value or nominal value, i.e. the additional amount paid by the investors per share above the nominal value of the stock is termed as additional paid-in capital on the balance sheet.
Whereas contributed capital is a total of the share capital, i.e. the sum of common stock (par value of shares) plus additional paid-in capital appearing on the balance sheet. Both additional paid-in capital and contributed capital are recorded on the balance sheet under the stockholder’s equity section. Additional paid-in capital is shown as a separate sub-heading, while contributed capital is not a separate heading or sub-heading; it can be determined by calculating the sum of common stock and additional paid-in capital.
Advantages
Advantages of the additional paid-up capital on the balance sheet are as follows:
- Additional paid-up capital does not increase the company’s fixed cost. The company does not pay anything to investors, apart from dividends which are not compulsory and are defined by the company’s policy year on year.
- It serves as a source of finance; the company can use the fund for day-to-day operations, buy assets, pay loans, etc.
- It serves as an additional layer of defense in the event of potential losses and when retained earnings are not sufficient to cover up the losses.
Conclusion
Additional paid-in capital is an important component of the total stockholder’s equity. The excess price per share over and above its nominal value paid by the investors is termed as additional paid-in capital on the balance sheet. It is also different from the market value of the share, which is determined by the market forces. The additional paid-in capital is an important source of finance for the business, and it also serves as a layer of defense in time of losses.
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