A public company may sell shares of its stock to raise money. The face value of a share is the par value, and the amount an investor is willing to pay is the market value. The difference between these two numbers is the paid-in surplus. This money is part of owner's equity but can't be used to pay dividends and isn't taxed as profit, so it's kept in a different account than retained earnings.
Owners create companies as corporations to provide a measure of liability protection; you can sue a corporation but you can't imprison one. It is a separate legal entity that issues stock and is owned by shareholders. Small business owners often own 100 percent of the shares. Selling shares and becoming a public company is a common way of increasing capital.
Initial Public Offering
When a company wants to go public, it works with an investment bank to implement an initial public offering, or IPO. The company offers shares for public sale at a price determined by the bankers and the company's executives; this is the par price. Often times, the IPO generates a considerable amount of interest and investors are willing to pay above-par prices for the stock. The difference between the par price and the market value is the paid-in surplus -- also known as paid-in capital.
Seasoned Equity Offering
A seasoned -- or secondary -- equity offering, or SEO, occurs when an established company wants to raise additional capital by selling shares. This dilutes the value of existing shares, and the public may view this as a sign that a company is failing. However, if the company announces that it is using the funds for expansion or improvement, the stock may sell above the par price, creating a paid-in surplus.
The sale of company stock appears on the balance sheet as owner's equity. The accountant records the par value as stated capital and the surplus portion of the sale as paid-in capital. The other contributor to shareholder equity is retained earnings, which reflects the company’s profitability. Companies keep paid-in capital and retained earnings in separate accounts because state laws prohibit a company from declaring a profit or loss on the sale of its own shares. Furthermore, because dividend payments are based on profit, they must come solely from the retained earnings account.
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