Premium - What is a Premium?
In finance and accounting, a premium is any additional cost charged on top of an asset’s usual cost.
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The concept of a premium is usually used in the context of bonds and stocks to refer to the difference between the stock or bond’s par value and the value it actually sells for.
Premium on stock
A premium on shares or stock - also known as stock premium or capital surplus - occurs when a stock or share is issued above its par value. The difference between the par value and the issuing value is considered the stock premium. For example, if a stock has a par value of £10 but is issued for £50, the share has a premium of £40.
Stock premium represents the amount that investors are willing to pay over par value, and therefore reflects the market value of the stock.
In the UK, stock may be issued at a premium (above par), but can not be issued at a discount (below par).
Accounting for premium on stock
When accounting for stock premiums, the par value of the stock should be recorded in the common stock account. The premium is then recorded in an equity account called ‘Additional Paid-in Capital’, ‘Paid-In Capital In Excess of Par’, or something similar. This account appears on the balance sheet under stockholders’ equity
Premium on bonds
A premium on a bond occurs when a bond is sold for more than its par value. To calculate the premium of a bond, subtract the par value from the issuing price.
Bonds can be issued above or below their par value due to changing interest rates. Investors pay a premium on a bond in order to receive higher interest payments over the bond’s lifetime.
Accounting for premium on bonds
Accounting for bonds involves several steps throughout the bond’s lifetime. If an investor purchases a bond at a premium, the difference between the par value and the issuing value should be recorded in account called ‘Premium on Bonds Payable’
When a bond is issued at a discount or a premium, amortisation should be applied throughout the bond’s lifetime.
Premium Bonds in the UK
When talking about premiums in relations to bonds, it is important to make a distinction between bonds issued at a premium and Premium Bonds. In the UK, ‘Premium Bond’ refers to a specific type of bond issued by NS&I.
Whereas regular bonds earn interest, when someone invests in Premium Bonds, they are entered into a monthly prize draw. The prizes range from £25 to £1 million. Between £100 (or £50 for existing holders) and £50,000 can be invested in Premium Bonds at one time, and every pound invested is equal to one entry.
Premium Bonds are not eligible for Capital Gains Tax or Income Tax, so are a commonly used by people looking for tax-free investments. On the other hand, Premium Bonds do not guarantee a Return on Investment, so might not be a good investment option for anyone looking for guaranteed returns.
Premiums and Debitoor
With Debitoor accounting & [invoicing software], it’s easy to keep track of your investments. Our financial reporting functions automatically generate balance sheets to give you an overview of your accounts.