Issue of Shares at a Premium (With Illustrations)

When shares are issued at a price higher than the face value (also called par value or nominal value), it is called an issue of shares at a premium. Excess of issue price over face value is the amount of premium; it is a capital profit for the company and the amount so earned has to be credited to a separate account called Securities Premium Account.

There are no restrictions on issue of shares at a premium and the power to issue shares at a premium need not be taken in the Articles of Association. But there are restrictions on the ways securities premium can be used.

According to Section 78 of the Companies Act, securities premium may be applied by the company for;

(i) Issuing to members of the company fully paid bonus shares; or

(ii) Writing off the preliminary expenses of the company; or

(iii) Writing off the expenses of, or the commission paid or discount allowed on issue of shares or debentures of the company; or

(iv) Providing for the premium payable on the redemption of any redeemable preference shares or debentures.

According to the Companies (Amendment) Act, 1999 a company may, subject to fulfillment of certain conditions, use the amount of its Securities Premium Account to buy back its own shares.

Any other application of securities premium will amount to a reduction of share capital. It is so because the provisions of the Companies Act relating to the reduction of share capital of a company apply to securities premium as if it were the paid-up share capital of the company.

Reduction of share capital can be carried out by a company if the company is authorized by its Articles of Association to do so after passing a special resolution and getting sanction of the court.

The company may collect the amount of securities premium in a lump sum or in installments. The amount of securities premium may be included in either application money or allotment money or a call. If nothing is mentioned to the contrary in a problem, it should be assumed that the entire amount of the securities premium is to be included in the allotment money.

If the amount of securities premium is included in the application money, the company will debit Bank and credit Share Applications Account with the amount received from applicants. On allotment of shares, the amount of securities premium in respect of shares allotted will be debited to Share Applications Account and credited to Securities Premium Account.

If securities premium is to be collected on allotment or a call, the company may adopt either of the following two courses:—

(i) When the allotment money (or the call) becomes due, Share Capital Account will be credited with the total amount becoming due on account of share capital and Securities Premium Account will be credited with the total amount of securities premium becoming due and with the total of the two, Share Allotment Account (or the relevant Share Call Account) will be debited.

On receipt of the money, Bank will be debited and Share Allotment Account (or the relevant call account) will be credited with the total amount received.

(ii) In the second method, the amount of securities premium will be ignored when the entry for making the allotment money (or the call) due is passed; thus Share Allotment Account (or the relevant Share Call Account) will be debited and Share Capital Account will be credited with the total amount becoming due on account of share capital and no entry will be passed for securities premium becoming due.

When the allotment money (or the relevant call) is actually received, Bank will be debited with the total amount received, Share Allotment Account (or the relevant Share Call Account) will be credited with the amount received on account of share capital and Securities Premium Account will be credited with the amount of premium received.

Considering that the Companies Act has placed restrictions on the applications of Securities Premium Account, the second method is considered better in which Securities Premium Account will be credited only when the amount of securities premium has actually been received in cash.

Illustration 1:

Good Prospects Ltd. issued 5,00,000 equity shares of Rs 10 each at a premium of Rs 2 per share, the terms of payment per share were as follows:

Rs 3 with application

Rs 4 on allotment

Rs 5 on first and final call.

The issue was fully subscribed. The call was also duly made. All moneys were received in time.

Pass journal entries for all the transactions in each one of the following cases:—

Case I: Securities premium is included in the application money.

Case II: Securities premium is included in the allotment money.

Case III: Securities premium is included in the call.

If securities premium is included in the allotment money and surplus applications money is appropriated towards part payment of allotment money, first the appropriation will be made towards that part of the allotment money which is payable on account of share capital and the balance, if any, will be appropriated towards securities premium payable.

Illustration 2:

Ideal Enterprises Ltd. was registered with an authorized share capital of Rs 75,00,000. It issued 6,00,000 equity shares of Rs 10 each at a premium of Rs 2 per share, payable as to Rs 3 with application, Rs 4 (including premium) on allotment and the balance on first and final call.

Applications were received for 12,00,000 shares. The Board of Directors accepted all the applications, allotment being made on pro rata basis. All the shareholders paid the balance of allotment money and the call in time. Pass journal entries for all the above mentioned transactions and prepare balance sheet of the company as it would appear immediately after the receipt of all the money due on call.