- When additional shares are allotted to existing shareholders without receiving any additional payments from them, it is known as issue of bonus shares.
- Bonus shares are allotted by capitalizing the reserves and surplus.
- Issue of bonus shares results in the conversion of the company’s profits into share capital. Therefore it is termed as capitalization of company’s profits.
- Such shares are issued to the equity shareholders in proportion to their holdings of equity share capital of the company, a shareholder continues to retain his/her proportionate ownership of the company.
Effects of bonus issue is two-fold:
- It amounts to reduction in the amount of accumulated profits and reserves.
- There is a corresponding increase in the paid-up share capital of the company.
By issue of bonus shares, the accumulated profits and reserves of the company is converted into share capital. This is called capitalization of profits and reserves.
When to issue bonus shares?
- When a company has huge accumulated profits and reserves and wants to capitalise them.
- When the company is not able to declare a high rate of dividend due to restrictions by the government, they can opt bonus issue.
- When higher rate of dividend is not advisable, as the shareholder may expect the same higher rate in the future as well.
- When the firm cannot issue a cash bonus, because of unsatisfactory cash position of the firm.
- When a company pays bonus shares to its shareholders, its liquidity position is not affected.
- Cash can be conserved and reinvested into the business.
- The investors doesn’t need to pay tax upon receiving bonus shares.
- It is beneficial for investors who prefer to have a long term association with the firm and want to increase their investment.
- If the company pays cash dividend in the future, the investor will receive more, as he hold a more number of shares.
- Not all investors maybe interested in receiving shares. Some may want cash for fulfilling other objectives.
- The proportion of the shares will not change as it remains the same.
- The reserves of the company will be reduced after bonus issue. This leaves lesser security to investors.
- The company has to follow the SEBI guidelines for bonus issue. This may result in the process being lengthy.
SEBI guidelines regarding issue of bonus shares
- The articles of association of the company should contain provisions for issue of bonus shares. If not, the company should pass a resolution at the general body meeting.
- Bonus issue shall be made out of free reserves made out of genuine profits or share premium collected in cash.
- Any reserve created through revaluation of fixed assets cannot be used for bonus issue.
- There should not be any default in payment of statutory dues to employees such as provident fund, gratuity, etc. There should also be no default in payment of interest or principal in respect of fixed deposit or debt securities.
- An issuer, announcing bonus issue after the approval of its board of directors, shall implement it within 15 days from date of approval.
- Once bonus issue is announced, it cannot be withdrawn.
Bonus issue vs Stock split
- Bonus issue means issue of bonus shares to the existing shareholders of the company by capitalizing the profits and reserves of the company.
- Stock split means, reducing the par value of the shares by increasing the number of shares proportionately, ie, a share of Rs.100 may be split into 10 shares of Rs.10 each
Bonus issue vs Rights Issue
- Bonus issue means issue of bonus shares to the existing shareholders of the company by capitalizing the profits and reserves of the company while Rights shares are fresh shares offered to the existing shareholders, at a discounted price, with an aim to raise more capital from the market.
- Bonus shares are offered to the shareholders free of cost while Rights shares are offered to the shareholders at a discounted price.
- Bonus shares are issued to keep the liquidity position at a favourable level while Rights shares are issued to fetch additional capital to the firm.