How to Calculate Share Premium

When a company issues shares, it sells them to investors in exchange for money. These shares can be sold at a price higher than their face value or nominal value. The difference between the price at which the shares are sold and their nominal value is called the "share premium." in other words, share premium is the difference between the issue price and the nominal value of the share, i.e., market value less par value.

To make it simple, let’s break it down:

• Nominal value (also called par value) is the value of the share as set by the company when the share is created. This value is usually a small amount, like $1 or $0.10, and it doesn't change, no matter what the share is sold for later.
• Issue price is the price at which the company sells the share to investors. The company may sell the share for more than its nominal value, and the extra amount is the share premium.

Why Do Companies Have Share Premiums?

When companies issue shares, they may want to raise more money than just the nominal value of each share. The share premium allows them to do this.

Here are some reasons why companies might sell shares at a price above their nominal value:

1. Raising More Capital: Selling shares at a premium allows a company to raise more money without increasing the number of shares it issues. For example, if a company issues 1,000 shares at a nominal value of $1, it would raise $1,000. But if those shares are sold at $5, the company can raise $5,000.

2. Reflecting Market Demand: Sometimes, shares are in high demand because the company is doing well, or investors expect the company to perform well in the future. In this case, the company might issue shares at a higher price, and the difference between the nominal value and the issue price becomes the share premium.

3. Value of the Company: If a company is successful and making good profits, investors may be willing to pay more for the shares. The company can set a higher issue price and collect the additional amount as share premium.

4. Attracting Investors: A share premium can show that the company is strong and has a good future outlook. Investors might be more willing to invest if they see that the company can sell its shares at a premium.

Learn how to calculate the share premium with the following examples:

(1) CC Company issued 250,000 shares for $1 each (nominal value) when it was formed 5 years ago. Today, the company has a market value of $1,000,000. Then, the market value of each unit of equity is = $1,000,000 / 250,000 = $4. Share premium = market value - nominal value = 4 - 1 = $3.

(2) QQ Company has an opening balance of share capital $200,000 and share premium $2,000. During the year, 35,000 ordinary shares of $1 were issued payable in installment (see below):
- On application $0.55
- On allotment (including share premium $0.20) $0.30
- On final call $0.35
Calculate the closing balance on the share premium account.

Solution:
The share premium on the shares issued is = 35,000 * $0.20 = $7,000
Total share premium (closing balance) = 2,000 + 7,000 = $9,000

* Next: How to Calculate Interim Dividend