Overview of the concept
Par value of the shares is a base amount and must be paid to acquire the company’s share. However, at the time of IPO – (Initial public offering), if the company receives an additional amount over PAR value of the shares (can be seen like profit), it’s said to be an additional paid-in capital. In simple words, additional paid-in capital is an excess amount received over the par value of shares.
Additional paid-in capital is credit in the balance sheet; the reason is that it’s a part of the company’s equity. The second impact of receiving additional paid-in capital is receipt of the cash, which is debit as the increase of the asset.
Explanation of the concept
When the company issues its shares for the first time in the market, it’s said to be IPO – (Initial Public Offering). The company is free to set any basic amount it feels fit for the share issues; it is par value. However, investors may elect to pay a higher price than par value; an additional cash receipt is classified as additional paid-in capital.
For instance, the company sets the par value of the shares to $1 per share for one million shares in total. However, investors are optimistic about the company’s future performance and bid $6 per share.
In this case, the company will receive $6 million and classify $1 million as common stock. On the other hand, $5 million will be classified as additional paid-in capital because it has been received as an excess of the par value.
The given scenario can be journalized as follows.
| Description | Debit ($000) | Credit ($000) |
| Cash/bank (Asset) | 6,000 | |
| Common stock (Equity) | 1,000 | |
| Additional paid-in capital (Equity) | 5,000 |
The debit impact of the transaction is receipt of the cash amounting to $6 million. It’s a simple increase of the assets that is debited in the balance sheet. On the other hand, the impact of first credit is a recording of the common stock, which is restricted to the par value of the shares. Likewise, the impact of the second credit is a recording of the additional paid-in capital, which is an excess amount received over and above the par value of $5,000 ($6,000-$1,000).
The following formula is used to calculate an additional paid-in capital.
Additional paid-in capital (APIC) = (The issued price of the share – PAR value of the share) X Number of shares
It’s equally important to note that recording for the paid-in and additional paid-in capital occurs at the time of IPO. However, once share trades in an open market, the trade is not recorded in the business books. Instead, it’s recorded in the books of investors.
Difference between paid in and additional paid-in capital
Paid in capital is the total amount of the cash received by the company from an investor. It includes the following two components.
Paid in capital = A+B, where
A = Common stock (par value of the shares)
B = Additional paid-in capital (cash received in excess of the PAR value)
So, paid-in capital is the total amount of shares received by the business during IPO. Both of these components are credited in the equity section. On the other hand, the debit impact is the cash receipt. It’s important to note that this transaction impact equity & assets, and both of these heads are classified in the balance sheet.
Further, it’s clear from the given equation that additional paid-in capital is part of paid-in capital.
Way to increase additional paid-in capital
The primary way to increase additional paid-in capital is by issuing shares in excess of the PAR value. The shares issued may be common share/preferred shares depending on the attributes.
Likewise, secondary ways can impact the balance of additional paid-in capital. For instance, credit impacts (increase) on this account can be seen in the following cases.
- Conversion of convertible bonds the common shares – If bonds are converted into common stock at a value in excess of the PAR value, an excess part is classified as additional paid-in capital and credited.
- Stockholder assessment – Sometimes, there can be voluntary assessments from stockholders to increase paid-in capital.
Likewise, the following can be debit impacts on the paid-in capital.
- Payment of liquidating dividend – Liquidating dividend is when company does not have sufficient profits/retained earnings to pay dividend. Instead, it uses additional paid in capital to maintain their trend of payment. So, paying liquidating dividend leads to decrease in additional paid in capital.
- Shares buyback– If the company buybacks its shares, related equity in accounts is reversed. The impact of buyback is opposite to the issue of shares and the net impact of compensation paid is first adjusted against additional paid in capital and then paid in capital.
Conclusion
Additional paid-in capital is an amount received in excess of the PAR value. The amount received to the extent of PAR value is classified as common stock/preferred stock, depending on the type of stock issue. However, an additional amount received above PAR value is additional paid-in capital.
Common/preferred capital and additional paid-in capital are credited in the equity. The reason is that its increase in the business equity. Further, the second impact of the transaction is an increase in the cash, which is debited in the balance sheet.
The concept of paid-in capital is only relevant when the company issues share via IPO – Initial Public Offering or any alternate method. So, the trade of the shares in the secondary market does not impact the company’s accounts.
The terms of paid-in and additional paid-in capital can be confusing sometimes. However, there is a difference, and additional paid-in capital is a component of the paid-in capital. In other words, paid-in capital comprises common stock/preferred stock and additional paid-in capital.
The prime way to increase additional paid-in capital is by issuing stock above PAR value. However, other ways to credit additional paid-in capital include conversion of convertible bonds to common stock and special stockholder assessment. Similarly, debit impacts can be shares buyback and paying a liquidating dividend.
Frequently asked questions
Provide an example of calculating additional paid-in capital with a formula.
Suppose TPL Company issues one million shares for $4 each and a PAR value of $1.
The following formula is used to calculate paid-in capital.
Additional paid-in capital (APIC) = (The issued price of the share – PAR value of the share) X Number of shares
Additional paid in capital (APIC) = (4–1) X 1,000,000
Additional paid in capital (APIC) =3 X 1,000,000
Additional paid in capital (APIC) =3,000,000
Given transaction can be journalized as follows.
| Description | Debit ($000) | Credit ($000) |
| Cash/bank (Asset) | 4,000 | |
| Common stock (Equity) | 1,000 | |
| Additional paid-in capital (Equity) | 3,000 |
The debit impact is recorded for the total cash received. On the other hand, credit postings lead to an increase in the total equity.
What’s the impact of retained earnings on the additional paid-in capital?
Retained earnings do not have a direct impact on the additional paid-in capital. Although, there is a direct impact on the closing equity balance. If the business makes losses, it reduces the profits, retained earnings, and total equity.
Is it possible to have a negative balance for a paid-in capital account?
Generally, it’s not possible to have negative paid-in capital. However, if you have a significant balance of the accumulated losses, it converts total equity into a negative balance.
When does the business record additional paid-in capital?
Additional paid-in capital can only be recorded when the company initially issues shares to the investors. Subsequent sell and purchases of shares do not impact the accounting record of the business.
What’s the difference between common stock and paid-in capital?
Paid-in capital is comprised of common stock and additional paid-in capital. The cash raised to the extent of PAR value of shares is classified as common stock, and the total of the common stock and additional paid-in capital is paid-in capital.
Additional paid-in capital is the excess amount received by the sale of the shares.