Contributed capital of a company is made up of two items; stocks and additional paid-in capital. The stocks section refers to the issued common stock usually. Thus, the term additional paid-in capital is one part of the total contributed capital.
Contributed capital is not borrowed money from investors. Once invested, the company does not need to repay the capital, unlike debt financing. Contributed capital and additional paid-in capital are both important sources of equity financing for any company. Both differ in some key areas as investors tend to invest in a company in return for shareholding.
What is Contributed Capital?
Contributed capital is money that investors invest in a company in exchange for stocks. These stocks can be common stocks, preferred stocks, or hybrid instruments. The contribution can be in the form of cash, assets, or cash equivalents by investors. However, the non-cash investment is less commonly termed as contributed capital.
Contributed capital or paid-in comes in the form of cash paid for stocks issued directly by the company. For example, a company issues 1 million common stocks in an IPO at a nominal price of $ 0.10 per share. Suppose the market price of shares is settled at $5, the company will receive $ 5.0 million. This amount is referred to as paid-in or contributed capital. The investors would become shareholders of the company.
Contributed capital can be raised through an IPO, direct public listing, rights issue, or private placements.
What is Additional Paid-in Capital?
Continuing with our example above, the company issues 1 million $ 0.10 shares. The shares are issued at a par value of $ 0.10. But investors would willingly pay a higher price per share than the par value. Several factors contribute to setting the market share price higher than the par value.
We further suppose, the market share price would settle at $5.0 and all shares are subscribed by investors. The company will now receive $ 5 million in cash. The premium paid above the par value of the shares refers to the additional paid-in capital or share premium. In this case, it is $ 4.9 million and $ 100,000 is the value of common stocks. Hence, the total contributed capital becomes $ 5.0 million.
Once issued the share prices can be traded amongst the shareholders directly or through stock exchanges. However, it does not affect the common stock or additional paid-in capital values. Only changes in these values come through additional shares issue or retiring shares permanently.
What are the Key Differences between Contributed Capital and Additional Paid-in Capital?
The key difference between the two terms contributed capital and additional paid-in capital is that one represents the book value of stocks issued and the other represents the premium paid above the par values.
Both of these items are entered in the owner’s equity section of the balance sheet. However, the contributed capital is the sum of the common stocks, preferred stocks, and additional paid-in capital. Contributed capital then becomes part of the total owner’s equity along with other comprehensive income and retained earnings of the company.
Retained earnings and additional paid-in capital (or share premium) are two key sources of capital for any business. The additional paid-in capital account cannot be used for just any investment purpose. For instance, it cannot be used to issue dividends to shareholders.
Uses of share premium account include:
- Issuing new or bonus shares to existing shareholders
- Covering equity issuing costs such as commission or fees paid for issuing shares
- It can be used for the share buyback program
- It can be used to cover the company’s underwriting costs
- Share premium can also be used to pay the premium on preference shares or other financial securities
On the other hand, cash collected through contributed capital can be used for any purpose. The contributed capital comprises the par value of stocks and shares premium. Both figures cannot be changed once issued and recorded in the balance sheet. Any changes in the figures arise due to issues or the retirement of shares only. When investors trade shares in the stock market (or privately), there is no change to the book values of these figures.
Contributed capital and share premium are both vital sources of equity financing for any company. Raising money through these sources does not increase the cost of financing. The company also has no legal obligation to pay dividends against the investment. Also, the share premium is set by the difference in the par value and the issue price. Investors can immediately redeem their investment by selling the shares in the stock market to gain profits.
Contributed capital and share premium are important sources of equity financing. Additional paid-in capital is the difference between the par value and the issue price of the shares issued by a company. It becomes part of the contributed capital, which in turn is part of the owner’s equity along with other items.