Updated July 13, 2023
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.
Creating it in the secondary market is impossible because buying and selling a company in the secondary market does not require the company to issue new shares and thus does not impact its share capital. We will learn about Additional Paid-Up Capital on the Balance Sheet in this topic.
Explanation
Additional paid-up capital is called ‘contributed capital in excess par’ or ‘share premium’. It brings out the fact of how much more the investors have paid above the nominal value of the company’s share, i.e., the difference between the actual price of the share and its nominal value.
The company mentions the nominal value of a share on the stock certificates, which is typically very small due to government mandates. The 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 the company issues stock in the primary market. Additional paid-in capital is also impacted when the company repurchases its 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 stock’s par value. 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
In its initial public offering (IPO), a company 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:
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 is a substantial share capital before the company’s retained earnings start building up.
- A source of contingency funds: In the event of potential losses and insufficient retained earnings, the additional paid-in capital is a 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 more flexibility in 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. Additional paid-in 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
The 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. Apart from dividends, which are not compulsory and are defined by the company’s policy, the company does not pay anything to investors.
- It serves as a source of finance; the company can use the fund for day-to-day operations, buy assets, pay loans, etc.
- When potential losses occur, and retained earnings are insufficient to cover them, it provides an additional layer of defense.
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 additional paid-in capital on the balance sheet. It is also different from the market value of the share, which is determined by market forces. Additional paid-in capital is vital finance source and acts as a defense layer during times of loss for the business.
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This is a guide to Additional Paid-Up Capital on Balance Sheet. We also discuss the definition and how to create additional paid-in capital on the balance sheet. Along with advantages. You may also have a look at the following articles to learn more –
