When a company goes for an IPO, it collects money that is higher than face value of the company. For accounting purposes, this additional money (or capital) is transferred to a separate account known as share premium account. This share premium account has to be considered as part of the total capital i.e. it has to be captured in company’s balance sheet. There are many different ways this premium account can be used. I will list few of them in very common layman language.
- Company pays bonus shares and/or options to many employees or services provided to the company. These bonus shares and options are paid from premium share account;
- Use it to balance out or writing off company’s expenses in issuing IPO;
- Use it to balance out or writing off commission paid for marketing expenses of IPOs;
- Use it to balance out or writing off discounts allowed to any issue of shares or debentures of the company;
- Use the money for share buy back;
- Use the money to fund growth and expansion for the company;
- It cannot be used for dividends.
In general, what I have seen is companies use share premium account for little bit of everything from the list above. Having said that, typically, the future expansion or growth plans gets the lowest percentage allocation. I cannot back it with any statistical data, but most of the time it is used for first five options listed above.
In some cases, many companies become little innovative in financial engineering, to use it for balance it against the loss. They bring the money out of share premium account and that way they either show reduced losses or no losses. In such cases, companies have to take approval from courts (is it difficult to create paper work to make a case for it? you be the judge!). Examples for such
- Firms using share premium account to hide loses
- Share premium account to write off non-performing assets.
- Indian government is mopping up crores to fund its deficits (more spending) and fund so called social programs (which have no accountability). It is like let selling little bit of property to fund extravagance life style.
So next time when there is an IPO, think where your premiums are going? It is going to fund those bonus shares, those investment banking firm discounts, services which does not affect companies bottom line, and fat paychecks. It do not have issues with companies following this route, but unfortunately, there is no limit to their greed.
share premium account