What is Additional Paid in Capital? — Its Definition, Calculation, and Importance
Additional paid-in capital (APIC) is recorded in the accounting book but is often overlooked when discussing the company’s share value. It refers to every extra dollar investors pay above the share price, showing their faith in the business.
Understanding APIC accounting is a crucial aspect for finance, but it can be a bit tricky if not done right. Thus, we have decoded what is paid in capital, all the related terms, and the calculations in this blog. Read it carefully to grasp the concept!
What is Additional Paid in Capital?
Additional paid-in capital is also known as capital surplus or share premium in the accounting equation. It is the amount that investors pay above the actual price or face value of the stock. But why does it exist? APIC accounting works based on legality. The face value of the stocks is usually nominal, like $0.01 or $1, which fulfils the state legal requirement. However, when the company’s shares are listed on the market, it is set at a higher market value because of the demand and growth.
The investors pay a higher market price to buy the shares, and the difference between the investor’s payment and par value or face value is what boosts the equity base of the business.
Characteristics of Additional Paid in Capital
Below-mentioned are the key characteristics of Additional Paid in Capital that you must know about:
- No Link with Revenue: APIC is excluded from the income statement. It has nothing to do with the regular business operations or cash flow.
- Permanent: Once the APIC is written in the accounting sheet, it stays there in the equity section until the company changes stock value or lists new stocks.
- No Link with Trading: APIC only works when the investors buy stocks directly from the listed company. In case of trading between the investors, the company does not receive any monetary benefit.
- Shareholders’ Equity: The Company generally lists its stocks to the public when it wants to raise funds without taking debt, and APIC contributes to the financial foundation with extra money.
Thus, you can simply say that APIC accounting is the extra trust money that investors give to the companies they believe will grow and establish themselves better in the future.
How is Additional Paid in Capital Calculated?
The APIC formula is crucial to maintain the additional financing of the company after the stocks are publicly listed. Here’s the simple formula to get started:
APIC = (Issue Price – Par Value) × Number of Shares Issued
Where,
- Issue Price: The actual price the company sells its shares to the investors in the market.
- Par Value: The minimal face value of the stock set to meet the legal value of the market.
- Number of Shares Issued: The Total number of shares the company sells to the investors in the market.
Example
Let’s understand what is paid in capital with an example. Axis Steels is a company dealing with metal and scrap for industrial usage and is now listing its 100,000 shares on the stock exchange.
Let’s say the issue price will be $10 and the par value is $1. Thus, the APIC is:
= (10 – 1) × 100,000 = $900,000
According to the result, Axis Steels has $900,000 as additional paid in capital and will be written under the shareholders’ equity in the balance sheet.
Importance of Additional Paid in Capital in Accounting
As we already learned that APIC has no link with the revenue of the company and makes no difference in net profit either. However, it holds a critical role in overall cost accounting and understanding the equity value in the market and stakeholder’s belief in the company’s future.
Here’s how APIC is like a window to a company’s value and growth potential:
- Shows the Trust: APIC is the biggest indicator of investors’ trust. The higher the APIC, the investors are willing to pay shows they see growth potential in the company. You can call it a clear vote for the company’s future. Examples are IPO and funding rounds for startups.
- Boosts Equity: APIC is recorded in the equity section for shareholders on the balance sheet, highlighting the positive aspect of the business. This money is not anticipated to be repaid, unlike a loan, and strengthens a company’s financial health and reduces its reliance on debt financing.
- Supports Transparency: The businesses with clear and transparent financials are supported and trusted by the investors. As the company lists the stocks, it displays APIC value, clearly establishing financial faith with the investors.
- No Affect of Market Fluctuations: The revenue or net profits usually depend on the market fluctuations. When the market is high, people tend to buy more into the company. However, APIC do not follow the market-based equity fluctuations. It serves as the benchmark of capital raised despite the crashing market.
- Streamlines the Capital Structure: During the auditing, the source of funding needs to be shared, whether it is via equity or debt. APIC offers insight in such cases. It clearly shows the amount generated by issuing shares to the market at a greater value than their par value. This explains how the business has financed its operations or expansion in the past.
While paid-in-capital is not really much talked about term like bookkeeping, revenue and gross profits, it is a component that strengthens the financial pillar of any business. Ignoring APIC can severely destroy the roots of every business.
Wrapping Up!
Additional paid in capital shows a clear picture not just of revenue or profit, but how much people are willing to bet on the future of the company. This shows the company’s strong reputation and boosts equity value in the market.
Whether you are a finance student, a business owner, or an accountant, understanding APIC accounting properly is crucial.. We have explained the term clearly with calculations and examples in this blog. Hopefully, this has cleared your doubts and will help to make informed financial decisions.
Read Next: Cash Flow Statement: See How to Calculate It and Draft One With Examples
Frequently Asked Questions
Ans: Paid-in capital is the total amount the investors pay, including the additional cost and par value. It is recorded permanently in the shareholders’ equity section of the company’s balance sheet.
Ans: The paid-in capital does not cause any direct changes in the valuation. However, it gives the idea that the company is trusted by investors who are willing to pay more than the nominal value.
Ans: The APIC is unaffected by the market fluctuations. Thus, once they are recorded, the amount value remains constant and is not influenced by any factor.
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