Capital Surplus

Capital Surplus

Capital surplus is often referred to as an additional amount you need to pay when you purchase shares that are sold at a value higher than their par value. It is also known as share premium or additional paid-in capital. It is an important part of shareholder’s equity, but none of it can be given or used by a shareholder as the funds are non-distributable. The funds can only be utilised by the company for its growth and development. It can also be used to buy back shares that were previously sold. 

What is Capital Surplus? 

The word surplus implies the difference between the actual value of the share (par value) and the value at which the share is being sold. Suppose you bought a few shares at $10 per share, but the actual value of the share is $1, then the difference would be $9. This $9 amount is what you would call a capital surplus.  

Understanding Capital Surplus 

Capital Surplus plays an important role in the stock market. Any stock that is sold over the par value will always have a capital surplus and the buyer will have to pay the surplus. However, some stocks do not have a par value, such stocks usually don’t generate any capital surplus. A capital surplus is a broad concept and doesn’t strictly apply to shares and stocks. It can also apply to adjustments related to tax or even conversion. A capital surplus can be triggered in different situations, including the following: 

• Initial Public Offering: Once a business goes public for the first time, it will start issuing shares at an offering price. The capital surplus would be the difference between the par value of the shares and their offering price. 
• Seasoned Equity Offering: When an existing public company starts issuing new shares, they do it at a price that is valued higher than the par amount. This added amount is calculated as capital surplus. 
• Stock Options and Grants: An employee can also exercise the company’s stock options. Alternatively, they can also receive stock grants. If they do it at a cost that is valued lower than the market price, then the difference in amount between the exercised price and the market price would be what you call a capital surplus. 

Capital Surplus Formula 

Here’s the formula you can use to calculate the capital surplus of a transaction. 

Capital Surplus = Excess/additional Amount – Par Value Amount 

This amount you get from the difference is the capital surplus that goes straight to the company and the company can choose to invest this amount of cash for expansion of operations or R&D. 

Benefits of Capital Surplus 

When you pay a capital surplus for the shares you purchased, it’s the company that retains it. They get to benefit from it by investing that amount to expand their operational scale, from expanding production to diversifying the entire portfolio. The company also holds the right to use the capital surplus to buy back any shares that the company have sold. 

Capital Surplus Example 

Suppose there’s an organisation named XYZ Corps that goes public through an IPO. They decide to issue 10,000 shares with a par value of $1 for each share. These shares then become open to investors for a price of $15 for each share. Now, that’s quite a steep increase in the price of shares of a company that just went public, but if investors think they can profit from it, they won’t hesitate. Now, for every share sold, they earn a capital surplus. Let’s calculate the surplus for the entire 10,000 shares. 

• For 10,000, the par value amount will be $1 * 10,000= $10,000 
• For 10,000, the actual sale value of the shares would be #15 * 10,000= $1,50,000 
• The capital surplus would be $1,50,000 – $10,000= $1,40,000 

So, the company XYZ Corps earns a surplus of $1,40,000 for the sale of 10,000 shares on a balance sheet. This amount is generated as a result of excess funds that the company procured by selling the shares over the par value. The company can use this fund to finance the growth of the company, but it cannot be used as payments paid to shareholders. In essence, shareholders don’t get a penny of the excess amount and all of it belongs to the company. 

Frequently Asked Questions