Investing Basics – Feel free to ask the most basic questions

The Securities Premium Reserve (also known as the Share Premium Account) is an account that represents the amount received by a company over and above the face value of its shares when it issues them. This premium is recorded in the balance sheet under the shareholders’ equity section.

Significance of Securities Premium Reserve:

1. Capital Cushion: It acts as a financial buffer or cushion for the company. Since it’s a part of shareholders’ equity, it can be used to absorb losses or support the company during financial stress.

2. Reflects Investor Confidence: A high securities premium reserve indicates that investors are willing to pay more than the nominal value of the shares, reflecting their confidence in the company’s prospects.

3. Non-Dilutive Capital: The premium is a source of funds without diluting the ownership stake of existing shareholders, as it doesn’t involve issuing new shares but rather a premium on the existing ones.

Uses of Securities Premium Reserve:

The Companies Act, 2013 in India, specifies that the securities premium reserve can only be used for specific purposes:

1. Issuance of Fully Paid Bonus Shares: The securities premium can be used to issue fully paid-up bonus shares to the shareholders. This increases the share capital of the company without requiring additional investment from the shareholders.

2. Writing Off Preliminary Expenses: Preliminary expenses incurred during the formation of the company, such as legal fees, registration fees, and promotional costs, can be written off against the securities premium reserve.

3. Writing Off Debentures or Preference Shares Issue Expenses: The securities premium reserve can be used to write off expenses, discounts, or commissions incurred during the issue of debentures or preference shares.

4. Redemption of Redeemable Preference Shares or Debentures: The securities premium reserve can be utilized to pay off premium amounts payable on the redemption of redeemable preference shares or debentures.

5. Buy-Back of Own Shares: The reserve can be used to finance the buy-back of the company’s own shares, subject to compliance with the relevant regulations.

Restrictions on Use:

• Dividend Payments: The securities premium reserve cannot be used for paying dividends to shareholders.

• General Purposes: It cannot be used for general corporate expenses or to cover losses, except under specific conditions such as writing off capital expenses.

Accounting Treatment:

The securities premium reserve is recorded under the “Reserves and Surplus” section of the shareholders’ equity in the balance sheet. It is not considered part of the free reserves and hence, cannot be freely distributed as dividends.

Conclusion:

The Securities Premium Reserve is a crucial part of a company’s financial structure, providing flexibility for specific strategic financial activities. Its restricted uses ensure that the funds are preserved for enhancing shareholder value or strengthening the company’s financial position rather than being utilized for operational or non-strategic purposes.