Definition: Bonus Shares imply the free additional shares given to the existing shareholders, depending on the number of shares held by them. Bonus shares are the accumulated earnings of the company which are not given as dividends, rather they are transformed into free shares.
It occurs when the company does not distribute profits, in the form of dividends, rather than it retain and use them to pay for the issue of fully paid-up bonus shares. Hence, it is like the payment of dividends as shares instead of cash. Further, the proportion of their existing holdings acts as a base for the allotment of bonus shares to the equity shareholders.
Consequently, the existing equity shareholders get few additional shares free of cost, which are being paid out of accumulated profits of the company. In this way, there is an increase in the issued capital of the company whereas there is no change in the company’s assets. And due to this very reason, the bonus issue is called Capitalization of Undistributed Profits.
A company can make an issue of fully paid-up bonus shares, from:
- Free Reserves
- Securities Premium Account
- Capital Redemption Reserve Account (made from profits for the redemption of redeemable preference shares.)
- Balance in Profit and Loss Account
- Balance in sinking fund created for the redemption of debentures, after they have been redeemed.
What are the circumstances in which Bonus Shares are issued?
From the Company’s point of view, there is one advantage that the Bonus shares do not result in cash flow, i.e. the company’s resources remain intact. This is because the accumulated profits or reserves become part of the share capital, which leads to an increase in the creditworthiness of the company. This generally happens when the company wants to expand.
Now coming to the circumstances in which bonus shares are issued:
- When the cash resource of the company is not adequate, for the payment of cash dividend.
- When the company wants to accumulate cash resources for the purpose of expansion or for the repayment of liability.
- When the company has accumulated large reserves and wants to indicate the actual earning capacity to its stakeholders.
Bonus Shares are issued:
- To meet the liquidity needs, the shareholders have the right to sell them. It does not amount to cash flow.
- They can also be issued with the aim of restructuring the company’s reserves.
When there is a bonus issue, the shareholders do not gain at all, because the market value of the share is based on the amount of dividend received. And when bonus shares are issued the profits will be distributed as dividends over a larger number of shares, which will automatically reduce the dividend per share and this, in turn, will reduce the market value of shares.
In this way, the shareholder will have a larger number of shares, but the total value of his/her holding remains the same because the shares held by him/her will be of smaller value after the bonus issue. Therefore, no entries are made in the books of shareholders when bonus shares are received.
Prerequisites for Issue of Bonus Shares
- It should be authorized by the articles of association of the company. That is to say, the company’s articles must have a provision regarding capitalization of reserves which allows the issue of bonus shares.
- The company must have sufficient undistributed profits
- It has been authorized in the general meeting of the company after the recommendation of the Board of Directors.
- When the company has declared the decision regarding the decision of the Board recommending the issue of bonus shares, it should not take back the same afterward.
- Prior approval of the Securities and Exchange Board of India (SEBI) has been received.
Eligibility for Bonus Shares
All the existing shareholders, at the time of issue, will be entitled to receive bonus shares. When the company declares the issue of bonus shares, it also declares the date on which the issue will take place, commonly known as the record date. And so, the investors who are the shareholders on the record date will receive bonus issues.
The term used to indicate ‘bonus shares’ between the announcement date and record date is ‘cum bonus‘. But after the issue of bonus shares on the record date, these are called ‘ex-bonus‘
What is the Record Date?
Record Date is the cut-off date which the company decides. The owner of the shares on this cut-off date will be entitled to receive the bonus shares.
SEBI Guidelines for Issue of Bonus Shares
- The issue must be made from free reserves created out of undistributed profits or share premium, whose collection is made in cash only.
- Issue of bonus shares cannot be made by the capitalization of reserves which are created by revaluation of fixed assets.
- The company should not make the announcement of the issue of bonus shares in place of dividends.
- If there exists partly paid-up shares outstanding on the date of allotment, it should be made fully paid up.
- The company has not defaulted in the payment of interest or principal amount, concerning the fixed deposits or debentures issued by it.
- The company has not defaulted in the payment of statutory dues of employees i.e. contribution to provident fund, bonus or gratuity.
- A company that declares the issue of bonus shares after it is approved by the board, is required to implement the same, within a period of six months, starting from the date on which such approval is made. Also, it shall not have the option to change the decision.
- A provision in the company’s articles regarding the capitalization of reserves should be there, otherwise, the company is required to pass a resolution at the Annual General Meeting (AGM) for capitalization of reserves.
- As a result of a bonus issue, when the subscribed capital and paid-up capital exceed authorized capital, a resolution must be passed at the AGM, to increase the authorized capital of the company.
- At the time of bonus issue, a certificate that is duly signed by the issuer company and countersigned by the statutory auditor or company secretary must be forwarded to the Securities and Regulations Board of India (SEBI), indicating that the conditions relating to the issue of bonus shares are met.
Points to be Noted
- The conditions or guidelines given by SEBI do not apply to bonus issues made by private companies and unlisted public companies.
- Also, it should not be made within twelve months is any public issue or right issue.
- These are not taxable at the time of issue in the hands of shareholders, but the shareholders are required to pay capital gains tax, at the time of selling.
A word from Business Jargons
If authorized by the company’s articles of association, it may capitalize profits by issuing fully paid bonus shares to its members. In this way, it can transfer the amount capitalized from the reserve account to the share capital account. These are issued free of cost to the members of the company.