Bonus Shares: Meaning and Advantages | Company

In this article we will discuss about:- 1. Meaning of Bonus Shares 2. Advantages of the Issue of Bonus Shares 3. Guidelines 4. Accounting Treatment.

Meaning of Bonus Shares:

Sometimes, a large amount of reserves are accumulated with the companies which are undistributed past profits, and the companies like to distribute these accumulated profits. In such cases, the company may issue the shares for this amount to its existing shareholders.

Bonus Shares implies an extra dividend to the shareholders of a company.

It may be distributed by way of:

(a) Cash Bonus or

(b) Share Bonus.

Cash Bonus is paid up by the company when it has large accumulated profits as well as cash to pay dividend. Bonus Shares are issued by a company when it wants to pay dividend by issuing shares. When a company desires to immobilize any portion to its accumulated profits, it may issue Bonus Shares to its members.

This implies:

(a) An increase in share capital and

(b) A distribution of the accumulated profits to the members without any release of the company’s asset.

Bonus or capital bonus is given by making partly paid shares as fully paid without getting cash from the shareholders or it is given by the issue of free fully paid shares. Such shares can be issued with the permission of the Controller of Capital Issues.

The following points may be noted:

1. The Bonus Shares are issued to the existing shareholders and not to outsiders.

2. Issue of such shares are made out of credit balance of accumulated profits.

3. It is a method by which the accumulated profits are capitalized by issue of free shares. No cash is received against the issue.

4. Profits are converted into shares and the shares are issued as an additional dividend.

When any profit or reserve of a company is permanently acquired by it, the amount so acquired is said to have been capitalized. For the purpose of capitalisation of profits or reserve fully paid shares may be issued free of cost to the shareholders in proportion to their existing holdings or partly paid shares held by them may be made fully paid without any payment being received from them.

Shares issued free of cost to the existing shareholders by way of capitalisation of profits and reserves are called Bonus Shares. As a result of such an issue, the shareholders receive few additional fully paid shares which have been paid for out of the accumulated profits and reserves of the company and the company’s issued capital increases, whereas the company’s assets remain the same.

It may be noted here that the Share Premium Account under Section 78(2) and the Capital Redemption Reserve Account under Section 80(5) can also be applied towards the issue of fully paid bonus shares.

Advantages of the Issue of Bonus Shares:

From the point of view of the company, the following advantages are noted:

1. Dividend can be paid without disturbing the liquid position of the Company.

2. The disparity between effective capital and actual capital can be eliminated.

3. The rate of dividend will come down to a normal level on account of distribution over an increased number of shares and thereby avoiding resentment either from the workers for increased wages or from the customers for reduced price.

4. It is an inexpensive way to raise capital for expansion.

From the point of view of the shareholder, the following advantages are noted:

1. It is equivalent to cash dividend because the shareholders can have money by selling the shares in the market.

2. The shareholders are provided with an opportunity to invest their income in a prosperous company which they are not likely to get in the market except at a high premium.

3. If the bonus is applied in extinguishing liability in respect of uncalled capital, the share will become fully paid up without involving the shareholders to pay further cash.

4. The shareholders are not required to pay any income tax which they would have to pay had the dividend been paid in cash.

Guidelines for the Issue of Bonus Shares:

The procedures to be followed for the issue of Bonus Shares are as follows:

1. Consent of the Controller of Capital Issues must be obtained.

2. The Company should furnish a resolution passed at general body meeting for bonus issue before an application is made to the Controller of Capital Issues.

3. Consequent to the issue of Bonus Shares if the subscribed and paid-up capital exceeds the authorised capital, a resolution must be passed at the general body meeting in respect of increase in the authorised capital necessary.

4. The Bonus issue is permitted to be made out of free reserves built out of the genuine profits or share premium collected in cash only.

5. Reserves created by revaluation of fixed assets are not permitted to be capitalised.

6. Development rebate reserve is considered as free reserve for the purpose of calculation of residual reserves test and is also allowed to be capitalised.

7. The residual reserves after the proposed capitalisation should be at least 40% of the increased paid-up capital.

8. The number of Bonus Shares at one issue cannot be more than the number of shares already held.

9. All contingent liabilities disclosed in the audited account, which have a bearing on the net profits, shall be taken into account in the calculation of the minimum residual reserves.

10. 30% of the average profits before tax of the company for previous three years should yield a rate of dividend on the expanded capital base of the company at 10%.

11. Declaration of bonus shares in lieu of dividend is not allowed.

12. Not more than two bonus issues will be allowed to a company over a period of five years.

13. Between two successive announcements of bonus issues by a company should be a time lag of at least 36 months.

14. Bonus issues are not permitted unless the partly paid shares, if any, existing are made fully paid up.

15. No bonus issue will be permitted if there is sufficient reason to believe that the company has defaulted in respect of the payment of statutory dues of the employees such as contribution of provident fund, gratuity, bonus etc.

16. Applications for issue of bonus shares should be made within one month of the bonus announcement by the board of directors of the company.

Accounting Treatment of Bonus Shares:

Cash Bonus

Bonus Shares

It means such bonus shares result in conversion of company’s profits into share capital, i.e., Capitalisation of profits.

There are two ways of such capitalisation:

Illustration 1 (Bonus in the form of fully paid shares at par):

A Company has a share capital of Rs 7, 50,000 in Equity Shares of Rs 10 each. Out of the above, 50,000 shares were issued and fully paid up. The Company’s General Reserve amounts to Rs 5, 00,000. The directors now propose to utilize the necessary amount from the general reserve for the purpose of declaring a bonus of Rs 2, 50,000 as fully paid bonus shares. The Articles of the Company permit such a course and necessary sanction has been obtained.

You are required to give journal entries in the books to record the new issue of bonus shares.

Solution:

Illustration 2 (Bonus in the form of fully paid shares at premium):

A Company has a share capital of Rs 7, 00,000 in Equity Shares of Rs 10 each which are quoted in the market at Rs 20. The company now declares a bonus of Rs 6, 00,000 out of its reserve and this bonus is to be paid by issue of fully paid Equity Shares of Rs 10 each at a premium of Rs 5 per share.

Give journal entries to record the transactions.

Solution:

Illustration 3 (To make partly paid shares as fully paid up):

A Limited Company with a subscribed capital of Rs 5,00,000 in shares of Rs 10 each had called up Rs 8 per share: As the Company built up a big reserve, it was resolved that a bonus of Rs 1,00,000 would be declared but of the reserve to be applied in making the shares fully paid.

Give journal entries in the books to record the transaction.

Solution:

Illustration 4:

The Balance Sheet of Cable Ltd. is given below as on 31st December:

The Board of Directors passes a resolution to capitalize a part of existing reserves and profits by issuing Bonus Shares. One Bonus share is being issued for every four Equity Shares held at present. For this purpose, Rs 10,000 are to be provided out of Reserve Fund and the balance out of the Profit and Loss Account. Show the journal entries to give effect to the resolution, and also show how they would affect the Balance Sheet of the Company.

Solution:

Illustration 5:

The following particulars appear in the Balance Sheet of Bharat Ltd. as on 31st December:

The company passed the following resolutions:

1. That the General Reserve be utilised in making the partly paid shares as fully paid up.

2. That further 1,000 fully paid Equity Bonus Shares of Rs 10 each be issued to the existing shareholders. For this purpose, general reserve should be utilised to the minimum extent.

You are required to pass the journal entries to record the above, and show the necessary items in the Balance Sheet as would appear after giving effect to the resolution.

Solution:

Illustration 6:

The Balance Sheet of India Ltd. as on 31st December is given below:

At the annual general meeting it was resolved:

(1) To pay a dividend of 10%.

(2) To issue one bonus share for every four shares held as on date of last Balance Sheet.

(3) To give existing shareholders the option to purchase one share of Rs 10 each at Rs 14 for every four shares held prior to the issue of bonus shares.

(4) To repay the debentures at a premium of 4%.

All the shareholders exercised the option in (3) above. Give necessary journal entries and prepare the Balance Sheet after the resolution has been given effect to. Ignore taxes.

Solution: