Issue of Shares at Premium, Reasons, Example

Issue of Shares at Premium occurs when a company issues shares at a price higher than their nominal or face value. The difference between the issue price and the nominal value is known as the premium. This practice often reflects the company’s strong financial performance or future growth prospects, attracting investors willing to pay extra. The premium amount is recorded in a separate account called “Securities Premium Account” and can be used for specific purposes, such as issuing bonus shares or writing off preliminary expenses.

Reasons of Issue of Shares at Premium:

1. Strong Market Performance

A company with a solid track record of financial performance and profitability can issue shares at a premium. The premium reflects investor confidence in the company’s ability to generate future returns. This high market performance increases demand for its shares, allowing it to charge a premium price.

2. Future Growth Prospects

Companies with promising growth opportunities, such as expansion plans, new product launches, or entering new markets, may issue shares at a premium. Investors are willing to pay more for shares if they believe the company’s future prospects are strong, anticipating higher returns on their investments.

3. Enhanced Company Image

Issuing shares at a premium can enhance the company’s image and market reputation. It signals financial stability and investor confidence, potentially attracting more investors and boosting the company’s public profile. This positive perception can be beneficial for future fundraising and business negotiations.

4. Attracting High-Quality Investors

By issuing shares at a premium, companies can attract sophisticated and high-quality investors who are willing to invest at higher valuations. This can result in a more stable and committed shareholder base, which is advantageous for long-term business stability and growth.

5. Funding Strategic Initiatives

The premium amount raised through the share issue can be allocated to strategic initiatives, such as acquiring new businesses, investing in research and development, or upgrading technology. This additional capital helps the company pursue its growth strategies without diluting its existing equity base.

6. Covering Issuance Costs

Companies incur various costs when issuing new shares, including legal fees, underwriting fees, and administrative expenses. Issuing shares at a premium helps cover these costs, ensuring that the company does not have to dip into its reserves or profits to fund the issuance.

7. Creating Financial Flexibility

The premium amount is recorded in the Securities Premium Account and can be used for specific purposes, such as writing off preliminary expenses or issuing bonus shares. This creates financial flexibility for the company to manage its capital structure more effectively.

8. Reducing Dilution Impact

Issuing shares at a premium can help reduce the dilution effect on existing shareholders. Since new shares are sold at a higher price, the dilution impact is less severe compared to issuing shares at their nominal value. This helps maintain the value of existing shareholders’ investments.

Journal Entries to be Passed at the Time of Issue of Share at Premium:

How to Utilize the Securities Premium Account:

1. Issue of Bonus Shares

• Purpose: To distribute additional shares to existing shareholders without any additional cost.
• Utilization: The premium amount can be used to issue bonus shares, converting reserves into equity. This is done by transferring the amount from the Securities Premium Account to the Share Capital account.

2. Writing Off Preliminary Expenses

• Purpose: To cover initial costs incurred during the formation of the company.
• Utilization: Preliminary expenses include legal fees, registration fees, and other costs incurred before the company starts its business operations. The Securities Premium Account can be debited to write off these expenses.

3. Writing Off Expenses of Issuing Shares

• Purpose: To cover the costs associated with issuing shares, such as underwriting fees and administrative expenses.
• Utilization: Costs incurred during the share issue process can be written off using the Securities Premium Account.

4. Providing for Premium on Redemption of Preference Shares

• Purpose: To set aside funds for redeeming preference shares at a premium, if applicable.
• Utilization: When preference shares are redeemed at a premium, the Securities Premium Account can be used to cover the additional amount over the nominal value.

5. Buying Back Shares

• Purpose: To repurchase shares from the market, often to reduce the number of outstanding shares or consolidate ownership.
• Utilization: When buying back shares at a premium, the Securities Premium Account can be utilized to cover the premium paid over the nominal value of the shares.

6. Reserves for Future Investments

• Purpose: To create a financial cushion for future investments or capital expenditures.
• Utilization: While direct utilization for investments is restricted, the premium amount can be used indirectly by converting it into other reserves or applying it to future financial strategies.

7. Reducing the Company’s Debt

• Purpose: To use premium funds to pay off debt, improving the company’s financial health.
• Utilization: Although not a direct application, premium funds can be used indirectly to strengthen the balance sheet by reallocating reserves and reducing liabilities.

8. Creating a Capital Redemption Reserve

• Purpose: To create a reserve for redeeming or repurchasing shares.
• Utilization: The Securities Premium Account can be used to create a Capital Redemption Reserve, supporting the company’s ability to manage its share capital structure.