What happens when an entity issues rights to its existing shareholders without consideration?
When an entity issues rights to its existing shareholders without consideration, the account that will be increased is the "Paid-in Capital in Excess of Par Value" account. Rights offerings are a way for companies to raise capital by offering existing shareholders the opportunity to purchase additional shares at a predetermined price. In this scenario, the rights are issued without consideration, meaning they are provided to the shareholders free of charge.
Understanding Paid-in Capital in Excess of Par Value
Rights Offerings and Capital Raise: Rights offerings are a common method used by companies to raise capital. By issuing rights to existing shareholders, companies provide them with the option to purchase additional shares at a set price. This allows companies to generate funds without incurring debt or seeking external financing.
Par Value and Additional Paid-in Capital: The par value of a stock is the nominal value assigned to each share by the company. It represents the minimum legal capital requirement and is typically a small amount, such as $0.01 per share. When shareholders purchase shares at a price higher than the par value, the excess amount is considered additional paid-in capital.
Impact on Financial Statements: When rights are issued without consideration, the company records the transaction by increasing the "Paid-in Capital in Excess of Par Value" account. This account reflects the amount of capital received from shareholders over and above the par value of the shares issued. It helps distinguish the premium paid by shareholders for the rights to purchase new shares.
Enhanced Shareholders' Equity: By increasing the "Paid-in Capital in Excess of Par Value" account, the company enhances its shareholders' equity. This demonstrates the additional capital raised through the rights offering and provides a clear picture of the funds generated through the issuance of rights.
In conclusion, when an entity issues rights to its existing shareholders without consideration, it increases the "Paid-in Capital in Excess of Par Value" account to reflect the additional capital raised through the rights offering. This helps distinguish the premium paid by shareholders from the nominal par value of the shares and enhances the company's shareholders' equity.