Capital surplus is a term that frequently appears as a balance sheet item as a component of shareholders' equity. Capital surplus is used to account for that amount which a firm raises in excess of the par value (nominal value) of the shares (common stock).
This is called as Additional paid in capital in US GAAP terminology but, additional paid in capital is not limited to share premium. It is very broad concept and includes tax related and conversion related adjustments.
Taken together, common stock (and sometimes preferred stock) issued and paid plus capital surplus represent the total amount actually paid by investors for shares when issued (assuming no subsequent adjustments or changes).
Shares for which there is no par value will generally not have any form of capital surplus on the balance sheet; all funds from issuing shares will be credited to common stock issued.
Some other scenarios for triggering Capital Surplus include when the Government donates a piece of land to the company.
The Capital surplus/Share premium account (SPA) is not distributable, however, in restricted circumstances it can be reduced:
- to write off the expenses/commission relating to the issue of those shares;
- to make a bonus issue of fully paid-up shares.
It may also be used to account for any gains the firm may derive from selling treasury stock, although this is less commonly seen.
Capital Surplus is also a term used by economists to denote capital inflows in excess of capital outflows on a country's balance of payments.
Many firms authorize shares with some nominal par value, often the smallest unit of currency commonly in use (such as one penny or $0.01), in many jurisdictions due to legal requirements. The firm may then sell these shares for a much higher price (as the par value is a largely archaic and fictional concept).
Any premium received over the par value is credited to capital surplus.
According to Companies Act 1985 s.130 and companies ordinance 1984 (Nepal) s.84:
(1) If a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account called "the share premium account".
(2) The share premium account may be applied by the company in paying up unissued shares to be allotted to members as fully paid bonus shares, or in writing off- (a) the company's preliminary expenses; or (b) the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company, or (c) in providing for the premium payable on redemption of debentures of the company.
(3) Subject to this, the provisions of this Act relating to the reduction of a company's share capital apply as if the share premium account were part of its paid up share capital.
A company's SPA is a part of creditors' buffer.
For example, a company issues 100 ordinary shares of a nominal value of $1 each at a subscription price of $4 per share. The $300 difference will go to the share premium account.
At the same time, the company issues 50 preference shares with a par value of $0.5. These shares are bought by investors for $1 each.
The firm's balance sheet at this point consists of only four items:
- Cash: $450
- Common stock: $100
- Preference stock: $25
- Share premium: $325
SPA = Number of new shares issued x (issue price - par value)