What are Bonus Shares?
Bonus Shares are shares that companies give to their existing shareholders in proportion to their already held shares at no cost. And is usually given by companies when they are short on cash, and investors demand regular income. There is no exchange of funds between the Shareholders and for the company, it is just a transfer of profits from retained earnings to the equity share capital of the company, and the allotted shares are transferred to the Demat account of the shareholders.
Bonus Shares Examples
Below are examples of bonus shares.
Example #1
Suppose a company equity account in balance sheet looks like this before bonus issue:
- Ordinary Shares 1,000,000 at $1 each = $1,000,000
- Share Premium Account = $500,000
- Retained Profit = $1,500,000
The company decided to give 1:5 bonus that mean shareholders will receive 1 share out of 5 shares held. So, in total new bonus shares issues will be 1,000,000/5 = 200,000
Total new share capital = 200,000*1 = $200,000
This $200,000 would be deducted from the Share Premium Account.
So new equity account after the bonus issue will look like below:
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- Ordinary Shares 1,200,000 at $1 each = $1,200,000
- Share Premium Account = $300,000
- Retained Profit = $1,500,000
Example #2
Suppose company A’s equity account in balance Sheet looks like below before issuing bonus:
- Ordinary Shares 1,000,000 at $1 each = $1,000,000
- Share Premium Account = $500,000
- Retained Profit = $1,500,000
The company decided to give a 1:1 bonus, which means shareholders will receive one share out of each share held. So, in total new bonus issues will be 1,000,000
Total new share capital = 1,000,000*1 = $1,000,000
This $1,000,000 would be deducted from the Share Premium account and retained earnings.
So new equity account after the bonus issue will look like below:
- Ordinary Shares 2,000,000 at $1 each = $2,000,000
- Share Premium Account = $0
- Retained Profit = $1,000,000
Bonus Shares Issue Journal Entries
The Company announces Bonus Shares in the form of a ratio, i.e., 1:2, this means every Shareholder who has 2 Shares. Hence if a Shareholder has 1,00,000 shares in his account, the Bonus = 1,00,000*1/2 = 50,000. So his total Holding would be 1,00,000 + 50,000 = 1,50,000 of which 50,000 Shares are allotted free of Charge.
In the above case, Lets say if the first 1,00,000 shares have been bought at $10 = 1,00,000*$10 = $1,000,000. Cost of 50,000 Shares = Nil. So Total Cost of 1,50,000 Shares = $10,00,000 thereby reducing the average cost to ~6-6.5 per share.
Below mentioned are some of the Journal Entries that need to be passed after issuing Bonus Shares:
- If the Issue is out of Retained Earnings (Face Value = $1)
- If the issue is out of Security Premium A/c
- Entries to be passed by the Shareholders in their Books of Accounts:
No Entries need to be passed. Just increase in the Holdings of the Shares with a Nil Costing. The Investor will show his Investments at the same value, but his average Cost of the Acquisition will come down drastically since the Bonus shares are allotted free of charge.
Differences Between Right Issue and Bonus Issue
- Right issues are for existing shareholders by raising additional capital by a corporation. These are to be issued from additional reserves and retained earnings.
- The right issue is issued to pump up additional capital, while bonus shares are issued as a gift to shareholders.
- Right shares are usually issued at a lower rate than the market, while bonus shares are issued at a proportion of originally issued shares and are free of cost.
Advantages
- Companies with low cash also can issued bonus shares instead of cash dividends.
- Company’s share capital size increases by issuing bonuses.
- It reduces the risk of allocating the retained profit into some loss-making projects.
- It increases liquidity, and thus shares price may increase following bonus issues.
- It boosts confidence among investors.
- If companies issue dividends, then shareholders will have to pay tax on that dividends, but they need not pay tax on the bonus shares until they sell it.
Disadvantages
- This does not generate any cash, but a total number of outstanding share capital increases; thus, if the company issue dividends in the future, then the dividend per share reduces.
- There can be the issue of overcapitalization because of a greater number of shares.
- This is taken out of retained earnings. This retained earning could be used for any new acquisition or a profit-making project, which could increase shareholders’ wealth.
Important Points
- It does not affect the total cash position of the company.
- Share market price reduced by the same proportion of that bonus share issue after the issuance date.
- Cash starved companies can use bonus shares issuance to reward its shareholders.
- It does not change the total equity position in the balance sheet of the company.
Conclusion
Bonus Shares are helpful for companies in a way that cash-starved companies can issue shares without spending any cash. It increases liquidity also and increase shareholders’ confidence also. But this move dilutes the capital even further. Because of dilution earning per share and dividend per share decreases for the shareholders.
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