Bonus shares are additional shares given to the existing shareholders in proportion to the shares they already hold. Bonus shares are given based upon the number of shares that a shareholder owns without any additional cost.
Sometimes, the company may decide to give bonus shares in the form of dividends. When companies are short of cash and don’t want to upset shareholders that expect a regular income, companies give away free shares to their shareholders that expect regular income.
Bonus shares don’t involve cash flow as it increases the company’s share capital but not its net assets. For example, a company may give one bonus share for every four shares held.
When a company’s share price is high, it becomes difficult for new investors to buy its shares. Companies issue bonus shares to increase their equity base.
If bonus shares are issued, an increase in the number of shares reduces the price per share, but the overall capital remains the same.
Bonus share is synonymous with scrip issues or capitalization issues although they have many differences.
Effects of Bonus Issue
When a company accumulates huge reserves and its balance sheet do not express a fair picture of its capital structure. The excess amount can be distributed among the existing shareholders of the company by a bonus issue.
Bonus issue amounts to a reduction in the number of accumulated reserves, and there is a corresponding increase in the company’s paid-up share capital.
A bonus issue can also be made to register as a public company by increasing the total share capital of a private company to make it eligible for re-registering as a public company.
From an accounting perspective, a bonus issue, a simple reclassification of reserves, causes an increase in the company’s share capital and an equal decrease in other reserves. So the total equity of the company remains the same.
Advantages of bonus issue of shares
- A company’s liquid resource can be maintained, and the working capital will not be affected when a company pays a bonus to its shareholders in the value of shares, not in cash.
- Bonus issue enables a company to use its reserves permanently and increase the company’s creditworthiness.
- A bonus issue is the cheapest and easiest method of raising additional capital to expand the business.
- By issuing bonus shares, new entrants can be restricted, and competition can be reduced.
- The company’s balance sheet will express a more realistic picture of the capacity and capital structure of the company.
- For the shareholders, the bonus shares may be a permanent source of income.
- Shareholders get dividends on a large number of shares, and they can easily sell these shares and get immediate cash if they wish to do so.
- The investor doesn’t need to pay any tax on receiving the bonus shares.
- The perception of the company’s size can be improved by issuing bonus shares as it increases the company’s issued share capital.
Disadvantages of bonus issue of shares
- Issue of bonus shares leads to a fall in the future rate of dividends as it is the only capital that increases, and earnings do not increase with the issue of bonus shares.
- The bonus share issue may cause future unhappiness among the shareholders because a fall in the future rate of dividends may cause a fall in the future market price of shares.
- After a bonus issue, the company’s reserves reduce, and it causes lesser security to investors.
Conditions for issuing Bonus Shares
There are some conditions that a company needs to follow before issuing bonus shares:
- The company must be authorized by the Articles of Association of the company to issue bonus shares.
- If the company’s authorized share capital is not enough for the issue of bonus shares, the company should increase the adequate number of shares.
- The company should authorize a bonus issue of shares in its General Meeting.
- The Board of Directors should recommend the issue of bonus shares in their meeting.
- The company has not defaulted in repayment of the deposits and debt securities.
- The company has not defaulted in any statutory dues of employees, such as bonuses and gratuity.
- All parties fully pay up the existing shares before the announcement of bonus shares.
- Once the decision to make a bonus issue is announced, it can not be withdrawn.