CAPITAL SURPLUS: CHARACTERISTICS, CALCULATION AND EXAMPLE - DUDAS - 2025

The surplus capital is capital or equity that can not be classified as capital or retained earnings. Most commonly, it arises when a corporation issues common shares and sells them at a price higher than their face value. Also known as the share premium, it is an account that can appear on the balance sheet of a company as a component of shareholders' equity.

The par value is the original price at which the company's shares were initially offered for sale, so potential investors could be assured that the company would not issue shares at a price below par value.

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In some countries, companies can set the face value at a minimum amount, such as $ 0.01 per share. As a result, almost all the price paid for a share will be recorded as a capital surplus.

The common shares issued and paid, plus the capital surplus, represent the total amount actually paid by investors for the shares when they are issued, assuming no adjustments or modifications are made.

Characteristics of the capital surplus

A capital surplus is additional paid-in capital that exceeds the nominal value paid by an investor when purchasing shares in an issuing entity. This amount represents the difference between the market value of the shares and their nominal value.

If a company issues shares that have no declared par value, then there is no capital surplus. Instead, funds from the issue of shares are recorded in the account of common shares issued.

Creation of capital surplus

There are five ways that you can create a capital surplus, which are as follows:

- Of the shares issued with a premium at the nominal or declared value, which is the most common form.

- Of the gains from the purchase of own shares and then resold again.

- From a reduction of the nominal value, or by the reclassification of the capital stock.

- From shares that have been donated.

- Due to the acquisition of companies that have a capital surplus.

Accounting accounts

When the corporation issues shares of its common stock and receives an amount greater than the par value of the shares, two accounting accounts are involved:

- The Common Shares account is used to record the par value of the shares that are issued.

- The amount that is greater than the nominal value is recorded in an account entitled Capital surplus, Capital paid in excess of common shares, or Premium on common shares.

Capital surplus and retained earnings

A portion of the company's profit almost always results in retained earnings, which has the effect of increasing shareholders' equity.

However, a specific part of the surplus comes from other sources, such as an increase in the value of fixed assets recorded on the balance sheet, the sale of shares at a premium, or a reduction in the par value of common shares.

These other sources are called capital surpluses and are placed on the balance sheet. That is, the capital surplus tells you how much of the company's equity is not due to retained earnings.

Both retained earnings and capital surplus represent an increase in the equity of an organization's shareholders, but both affect it in different ways.

The capital surplus is the amount of money or assets invested in the company by the shareholders, while the retained earnings are the gains realized by the organization, but not yet paid to the shareholders.

How is it calculated?

In the annual report of the balance sheet of a company, the last section of the balance sheet, called "Shareholders' equity", is searched.

In this section, the item called "Common Shares" is identified and the share issue price, the nominal value per share and the total number of shares issued are searched, listed with their description in each individual item.

The number of shares issued is the number of shares that the company has sold to investors.

If the company does not report the issue price per share on the balance sheet, it can do so in the footnotes of the annual report or in the annual report for the year in which the shares were issued.

For example, suppose a company issued 10 million shares at an issue price of $ 10 per share. However, the par value of these shares is $ 1 per share.

Steps to follow

First, the number of shares issued is multiplied by the nominal value per share, in order to calculate the total nominal value of the common shares, which is the amount that the company reports in the corresponding item.

For this example, multiply 10 million by $ 1, to get $ 10 million in total par value of common stock.

Second, the number of shares issued is multiplied by the issue price to calculate the total income the company received from the issue of its common shares.

For this example, multiply 10 million shares by $ 10, to get $ 100 million in total profit from the sale of the common stock.

Third, the total par value of the common shares is subtracted from the total income in order to calculate the excess paid for the common shares.

For this example, then $ 10 million in face value is subtracted from the $ 100 million in total earnings, to get $ 90 million in paid surplus.

This is the amount that the company reports in the caption "Capital Surplus" on its balance sheet.

Example

Suppose ABC Company sells 100 shares of its common stock for $ 9 per share. Therefore, the total sale of these shares is 100 shares x $ 9 = $ 900. On the other hand, it is known that these common shares have a registered par value of $ 1.

To record this transaction in the accounting, then $ 100 of the $ 900 of the total sale (100 shares x $ 1 par value) would be recorded in the common stock account, and the remaining $ 800 would be recorded in the capital surplus account.

Consequently, a company acquires a capital surplus through the sale of its shares to investors at a price that is above the designated nominal value of the share. The incremental amount above the face value will be identified as the capital surplus.

References

1. Will Kenton (2018). Capital Surplus. Investopedia. Taken from: investopedia.com.
2. Wikipedia, the free encyclopedia (2018). Capital surplus. Taken from: en.wikipedia.org.
3. Steven Bragg (2018). Capital Surplus. Accounting Tools. Taken from: accountingtools.com.
4. Harold Averkamp (2019). What is capital surplus? Accounting Coach. Taken from: accountingcoach.com.
5. Elise Stall (2019). Surplus vs. Retained Earnings. Small Business - Chron. Taken from: smallbusiness.chron.com.
6. Bryan Keythman (2017). How to Get the Common Stock and Paid in Surplus on a Balance Sheet. Pocket Sense. Taken from: pocketsense.com.