Bonus Share

When the add itiona l shares are a l lotted to the existing shareholders without

receiving any add itiona l payment from them, it is known as issue of bonus

shares. Bonus shares are a l lotted by capita l izing the reserves and surplus.

Issue of bonus shares resu lts in the conversion of the company's profits into

share capita l . Therefore it is termed as capita l ization of company's profits.

Since such shares are issued to the equ ity shareholders in proportion to their

hold ings of equ ity share capita l of the company, a shareholder continues to reta in

h is / her proportionate ownersh ip of the company.

Issue of bonus shares does not affect the tota l capita l structure of the company.

It is simply a capita l ization of that portion of shareholders' equ ity wh ich is

represented by reserves and surpluses.

It a lso does not affect the total earn ings of the shareholders.

Issue of Bonus Shares is more or less a financia l g imm ick without any rea l

impact on the wea lth of the shareholders. Sti l l firms issue bonus shares and

shareholders look forward to issue of bonus shares.

Reasons for issuing Bonus Shares

1 . The bonus issue tends to bring the market price per share with in a more

reasonable range.

2. It increases the number of outstand ing shares. Th is promotes more active

trad ing .

3. The nom ina l rate of d ividend tends to decl ine. Th is may d ispel the impression

of profiteering .

4. Share capita l base increases and the company may ach ieve a more

spectacu lar size in the eyes of the investing company.

5. Shareholders regard a bonus issue as a strong ind ication that the prospects of

the company have brightened and they can reasonably look for an increase in

tota l d ividend .

6. It improves the prospects of ra ising add itiona l funds.

Regulation of Bonus Issues

Important regu latory provisions govern ing issue of bonus shares are:

1 . The bonus issue is made out of free reserves bu i lt out of the profits or share

prem ium col lected in cash on ly.

2. The residua l reserves after the proposed capita l ization sha l l

Stock Spl its

In a stock spl it the face va lue per share is reduced and the number of shares is

increased proportionately.

A stock spl it is sim i lar to a bonus issue from econom ic point of view. But there

are some d ifferences from the accounting point of view.

Difference between Bonus Issue and Stock Split

Bonus Issue Stock Spl it

1 . The par va lue of share is unchanged . 1 . The par va lue of share is reduced .

2. A part of the reserves is capita l ized . 2. There is no capita l ization of reserves.

Advantages of issue of bonus shares to the company

1 . Conservation of Cash:

Issue of bonus shares does not involve cash outflow. The company can reta in

earn ings as wel l as satisfy the desire of the shareholders to receive d ividend .

2. Keeps the EPS at a reasonable level:

A company having h igh EPS may face problems both from employees and
consumers.

Employees may feel that they are underpa id .

Consumers may feel that they are being charged too h igh for the company's

products.

Issue of bonus shares increases the number of shares and reduces the earn ing

per share.

3. Increases the marketability of company's shares:

Issue of bonus shares reduces the market price per share. The price of the share

may come with in the reach of ord inary investors. Th is increases the marketabi l ity

of shares.

4. Enhances prestige of the company:

By issu ing bonus shares, the company increases its cred it stand ing and its

borrowing capacity. I t reflects financia l strength of the company.

5. It helps in financing its projects:

By issu ing bonus shares, the expansion and modern ization programmes of a

company can be easi ly financed . The company need not depend on outside

agencies for finances.

6. Retention of managerial control:

Any new issue of shares

bonus shares are issued to the existing shareholders in proportion to their

current hold ings, there is no threat of d i lution of manageria l control over the

company.

Advantages to the shareholders

1 . Tax benefits:
When a shareholder receives d ividend in cash , it adds to h is tota l income and is

taxed at usua l income tax rates.

From th is point of view the bonus shares increase the wea lth of shareholders. In

case the shareholder requ ires cash he can sel l h is add itiona l shares.

2. Indication of higher future profits:

Issue of bonus shares is genera l ly an ind ication of h igher future profits.

Th is is because a company declares a bonus issue on ly when its earn ings are

expected to increase.

3. Increase in future dividend:

The shareholder wi l l get more d ividends in the future even it the company

continues to offer existing cash d ividend per share.

4. High psychological value:

Issue of bonus shares is usua l ly perceived positively by the market. Th is tends to

create greater demand for the company's shares. In fact, a lways the share prices

rise at the declaration of bonus shares.

Limitations of Bonus Issues

Disadvantages for the company:

1 . Issue of bonus shares leads to an increase in the capita l ization of the

company. The increased capita l ization can be justified on ly if there is increase in

the earn ing capacity of the company.

2. After the issue of the bonus shares the shareholders expect the existing rate of

d ividend per share to continue. It is rea l ly a cha l leng ing task for the company to

reta in the existing rate of d ividend per share.

3. Issue of bonus shares prevents new investors from becom ing the

shareholders of the company (no doubt they can buy the shares in the secondary
market).

Disadvantages to the shareholders:

1 . Some shareholders may prefer cash d ividend to stock d ividend , such

shareholders may feel d isappointed (no doubt they can very wel l sel l their bonus

shares and get their money).