Definition: A premium on stock occurs when the stock’s par value is lower than the issuing price. The difference between the lower par value and the higher issuing price is considered the stock premium. This shows the amount of money that investors are willing to pay over the par value for the stock.
What Does Stock Premium Mean?
A premium indicates the value of the shares and the market’s expectations for the company. The company must be doing well or have investors interested in future prospects in order for them to be willing to pay more than the par value per share.
Accounting for stock premiums is simple. The common stock account is used to record the par value of the stock issued and a separate account called paid-in capital in excess of par is used to record the premium. The paid-in capital account is an equity account that represents the amount of money investors have contributed to the company over the par value of the stock. This account is usually listed on the equity section of the balance sheet below the common stock account.
Let’s take a look at an example.
Kathy’s bicycle repair shop is a small corporation with three shareholders. Kathy wants to issue an additional 1,000 shares of $10 par stock to two new investors in order to raise capital for a new expansion project. Since the bike shop is doing so well, Kathy’s investors are willing to pay $30 per share.
Kathy records the stock issuance by debiting cash for $30,000, crediting common stockfor $10,000, and crediting paid-in capital in excess of par for $20,000. As you can see, the common stock account is only used to record the par value of the newly issued shares. The paid-in capital account records the full premium that the new investors were willing to pay for the shares.