Legal Capital
| Legal capital serves to protect the interests of creditors, and represents the amount of owners equity that cannot be distributed to shareholders. |
Legal capital refers to the portion of owners equity and assets that cannot be distributed, and is therefore permanent in nature. States require companies to maintain legal capital in order to protect creditor’ claims to assets.
Legal Capital and Par Value
Traditionally legal capital referred to the par value or the stated value of a company’s common and preferred stock shares issued. Any stock shares issued over par value was considered additional paid-in capital over par value, also sometimes referred to as capital surplus.
For example, if Sunny incorporates Sunny Sunglasses Shop and issues 25,000 common stock shares at $1 par value, the common stock issued at par equals $25,000.
Any additional amount that the company receives for issuing the stock is recorded as additional paid-in capital in excess over par. If Sunny receives $2 per share, additional paid-in capital equals $25,000 as recorded below:
Par Value and Additional Paid-In Capital
| Account | Debits | Credits |
| Cash | $50,000 | – |
| Common Stock @ Par, $1, 25,000 Shares | – | $25,000 |
| Additional paid-in capital | – | $25,000 |
Par value does not represent the actual value of the stock, but rather is an arbitrary or nominal amount determined in the corporate charter. Most state laws prevent companies from issuing stock shares below the par value to protect future investors. For this reason, par value is often set at a minimal price.
When stock shares do not have a par value, the company Board of Directors may assign a stated value to the stock to determine legal capital, or the amount of owners equity that the company must maintain after issuing dividends and buying back its stock.
When the stock shares are issued, the excess over the stated value is also recorded as additional paid-in capital account similar to the example above, except that the company records the issuance of stock shares at the determined stated value.
In the example above, Sunny could not declare a dividend in excess of $25,000 legal capital determined by the par or stated value of the stock shares.
Legal Capital and Total Contributed Capital
In recent years, many states no longer require a corporation to have a par value assigned to the stock. States that have adopted these provisions have eliminated the distinction between par value and the amount contributed in excess of par.
Therefore, many states require legal capital in the amount of the total proceeds received from the issuance of stock. In this example, legal capital would equal $50,000. In other words, these states only allow the payment of dividends and stock buybacks from retained earnings and not from contributed capital.
Actions taken by a corporation that could affect legal capital should be considered in light of the state laws where the company was incorporated.
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Formula :
Shares with par :
Share capital
+Subscribed share capital
=Legal Capital
Share without par :
Share capital
+Subscribed share capital
+Premium in excess of stated value
=Legal Capital
Legal Capital = Ordinary Shares Issued + Preference Shares Issued + Subscribed Shares (Ordinary and/or Preference)
Thanks for that answer monkey. But i would also like to know why does the share premium on PS is not part of the legal capital.
Thanks for the answer.
For those who want a formula/quantified Legal Capital(LC)
(1) _If Ordinary Capital Stocks(OCS) has par value_
LC= Total Par Value(Ordinary & Preferred)
LC= Total Paid-in Capital
LC= OCS + PCS + SCS
Note:
PCS – Preferred Capital Stock
SCS – Subscribed Capital Stock
(2) _If OCS has No Par Value_
LC= OCS + SP Ordinary + PCS
Note:
-SP = Share Premium
-SP Ordinary = Additional Paid-in Capital(APIC)
-As explained in the article, if it is No Par value Shares/Stocks, the legal capital is the total proceeds from issuance of OCS which includes the SP or APIC or the excess.
-But SP/APIC/Excess of Preference will never be part of Legal Capital.
-In No Par Value OCS, subscription is not allowed since no par value OCS must be FULLY PAID always. Thus, not included in 2nd Formula.
Cash. XX (Legal Capital)
OCS/PIC. XX
SP/APIC. XX
#
Cash. XX
PCS. XX (Legal Capital)
SP/APIC. XX
#
Don’Care:
The easiest formula to remember legal capital is the number of shares x the par value. However, many states use various definitions to determine legal capital.
Thank you, Richelle!
wtf. i know what it is. i want the formula ! something like
issued + subscribed = legal capital
why do you have to make things so complicated when you can answer directly ! what the hell is wrong wih everyone ! then leave a note saying
note: include subscription receivable IF : SHARES ARE AT STATED VALUE. ETC !
I’m not sure thats why im searching. but instead you people put whats already in the book ! what’s wrong with you ?
Nice!