Companies raise equity finance through the issue of shares to shareholders. These shares are issued at a pre-determined rate known as the nominal value of the share.
This value is defined in the memorandum of association of the company. A company can issue the shares to its shareholders at the nominal value or a price above the nominal value of the shares.
The price difference between the nominal value of the share and the actual price, if there is a difference, is known as the share premium.
For example, a company issues 10,000 shares to its shareholders that have a nominal value of $100. If the shares are issued at the nominal value, i.e. $100, the accounting entry for the issue will be as follows:
Dr Cash/Bank (10,000 x $100) 100,000
Dr Share Capital (10,000 x $100) 100,000
However, if the shares are issued at $120 instead of the $100 nominal value, the accounting entry will be as follows:
Dr Cash/Bank (10,000 x $120) 120,000
Dr Share Capital (10,000 x $100) 100,000
Dr Share Premium (10,000 x ($120 – $100)) 100,000
The share premium of the company is a reserve account for a company and cannot be distributed among the shareholders.
The uses for a share premium account are limited and mostly used to pay off equity expenses. One of the major uses of the share premium account is to pay for the bonus share issue.
Bonus Share Issue
Bonus share issue, also known as scrip issue or capitalization issue, is an offer to shareholders to receive extra shares without having to pay for them.
Bonus shares are issued to shareholders as an alternative for paying cash dividends. These issues are given to shareholders free of charge based on the existing number of shares they hold.
For example, 1 bonus share may be issued for every 3 shares a shareholder possesses.
When bonus shares are issued, the accounting entry is different from normal issue of shares.
Bonus shares are issued from the reserves of a company. If no reserves are available, the shares are issued from the profit or loss account or retained earnings.
Accounting Entry
A company ABC Co. has 10,000 issued shares with a nominal value of $100 per share.
The company issues bonus shares of 1 for every 5 issued shares. This means a total of 2,000 (10,000 x 1 / 5) have been issued as bonus.
The accounting entry, assuming the company has a share premium equivalent or above $200,000 will be:
Dr Share Premium (2,000 x 100) 200,000
Cr Share Capital (2,000 x 100) 200,000
If the company does not have a share premium account at all, the entry will be as follows:
Dr Retained Earnings 200,000
Cr Share Capital 200,000
If the company has a share premium balance lower than $200,000, then the share premium reserves will be net off first and any remaining amount taken to retained earnings. The priority for bonus shares issued will always be first from reserve accounts and last from retained earnings.
Conclusion
Companies issue shares to raise finance. Shares are issued at a nominal price or higher. The price difference between the nominal rate and the higher actual price of issued shares is known as the share premium.
Bonus shares are shares that are issued to shareholders for free. The bonus shares issued are set off using the capital reserves accounts first, such as share premium, with the remainder taken to retained earnings.
