A share premium account is a reserve within shareholders' equity that holds the difference between the price at which a company issues its shares and their nominal value. If a share with a nominal value of 1 is issued for 5, the extra 4 is share premium. The account exists in legal systems where shares have a nominal or par value, including the United Kingdom, Ireland, most of the European Union and many Commonwealth countries.
The account is treated by law as part of the company's capital and not as profit. It cannot be paid out as a dividend, and it can be used only for a short list of purposes. In the United States, the corresponding balance is usually called additional paid-in capital, a component of paid-in capital, and is governed by state law instead of a single national statute.
How it arises
When a company issues shares, the proceeds are split in its books. The nominal value of the new shares is credited to share capital, increasing issued share capital, and anything received above that is credited to share premium. Companies normally set a low nominal value and issue at market price, so share premium is often much larger than share capital itself.
For example, a company issues 1,000 shares with a nominal value of 1 each at a price of 5 per share and receives 5,000 in cash. It records 1,000 in share capital and 4,000 in the share premium account. If the same company later issues another 500 shares at 9, share capital rises by 500 and share premium by 4,000. Premium arises in the same way when shares are issued for assets other than cash, based on the value of what is received.
Permitted uses
The rules are strictest in UK-style systems. Under the Companies Act 2006, the account may be applied only to:
- Paying up bonus shares. The company may use the balance to issue new fully paid shares to existing members; the operational side is described under bonus issue processing.
- Writing off issue costs. The expenses of an issue of shares, and commission paid on it, may be charged against the premium arising on that same issue.
Older law allowed wider uses, such as writing off the costs of forming the company, but these were removed. Beyond the permitted uses, the balance can be released only through a formal capital reduction, approved by shareholders and supported either by a court order or, for private companies, by a directors' solvency statement. Once reduced, the amount becomes a distributable reserve or can be repaid to members as a return of capital.
Why the restriction exists
The restriction follows from the doctrine of capital maintenance. Creditors of a limited company can look only to the company's assets, so the law requires that the money shareholders have subscribed stays in the business as a buffer and is not handed back while debts remain. Treating premium in the same way as nominal capital prevents a company from avoiding the rule by issuing shares with a tiny nominal value. The combined amount is sometimes described as the company's legal capital, and dividends may be paid only out of accumulated realised profits held in retained earnings.
Reliefs and special cases
Company law provides exceptions where recording a premium would give an unhelpful result. In the UK, merger relief applies when a company issues shares to acquire at least 90 per cent of the equity of another company: the excess over nominal value need not go to share premium and is usually recorded in a separate merger reserve. A similar relief applies to certain reorganisations within a group. These reliefs matter because reserves other than share premium are easier to distribute later.
Where shareholders choose a scrip dividend, the excess of the reference price over the nominal value of the new shares is credited to share premium. When a company carries out a share buyback out of profits and cancels the shares, the premium account is generally unaffected, and an amount equal to the nominal value cancelled is moved to a capital redemption reserve.
Presentation in the accounts
Share premium appears as a separate line within equity on the balance sheet, directly after called-up share capital, and movements during the year are shown in the statement of changes in equity. Accounting standards require disclosure of the nature and purpose of each reserve. Analysts add share capital and share premium together to see the total contributed capital that owners have put into the business, as distinct from profits it has earned and kept. Banking rules count share premium linked to ordinary shares as part of Common Equity Tier 1 capital.