Bonus shares are shares issued to shareholders of a company free of any cost.
Bonus issue is also known as scrip issue and scrip dividends.
Explanation
As an alternative to cash dividends, companies at times give away free shares to their shareholders when they are short of cash and don’t want to upset shareholders that expect a regular income. Shareholders can then sell the bonus shares to meet their liquidity requirements. Bonus shares are also issued to restructure company reserves.
Issuing bonus shares does not involve cash-flow. It increases the share capital of the company but not its net assets.
Bonus shares are issued to each shareholder according to their stake in the company. For example, a 3 for 2 bonus issue would entitle each shareholder 3 shares for every 2 shares already held by them before the issue. e.g. A shareholder having 1000 shares would therefore receive 1500 bonus shares (1000 x 3 ÷ 2).
Accounting
From an accounting perspective, a bonus issue is a simple reclassification of reserves which causes an increase in the share capital of the company on the one hand and an equal decrease in other reserves. The total equity of the company therefore remains the same although its composition is changed.
Following journal entries are required to account for a bonus issue:
|
Debit |
Undistributed Profit Reserves / Share Premium Reserve / or Other reserves |
Number of bonus shares × nominal value of 1 share |
|
Credit |
Share Capital Account |
Number of bonus shares × nominal value of 1 share |
Which reserves can be used to debit a bonus issue?
Any reserve could be used to debit a bonus issue (other than share capital reserve!) subject to limitations imposed by law.
Non-cash reserves such as the revaluation reserve are generally not utilized for the purpose of bonus issue due to legal restrictions under company law.
The specific reserve to be used or the order in which more than one reserves are to be utilized for a bonus issue is usually mentioned in the company’s standard operating procedure (SOP) manual, articles of association and / or the company resolution approving the bonus issue.
Example
BC PLC declared a 3 for 2 bonus issue.
Extract of ABC PLC’s balance sheet prior to issuance of bonus shares is as follows:
| $ | |
|---|---|
|
Ordinary Share Capital $0.5 each |
2,000,000 |
|
Share Premium Account |
1,000,000 |
|
Revaluation Reserve |
1,500,000 |
|
Retained Profits |
5,000,000 |
|
|
9,500,000 |
Company’s Standard Operating Procedures Manual requires that for the purpose of accounting for bonus issue, revaluation reserve should not be used whereas retained profits should only be used if other reserves are exhausted.
State the journal entries required to account for the above transactions and prepare extract of the balance sheet after bonus issue.
Journal Entries
|
Debit |
Share Premium |
$1,000,000 |
|
Debit |
Retained Profits |
$2,000,000 |
|
Credit |
Share Capital |
$3,000,000 |
Working:
Total number of shares before bonus issue = $2,000,000 ÷ $0.5 = 4,000,000
Bonus shares to be issued = 4,000,000 x 3 ÷ 2 = 6,000,000
Increase in share capital = 6,000,000 x $0.5 = $3,000,000
Amount to be offset from Share Premium Account = $1,000,000
Remaining amount to be offset from retained profits = $2,000,000 ($3m – $1m)
| Balance Sheet (Extract) | ||
|---|---|---|
|
|
$ |
|
|
Ordinary Share Capital $0.5 each |
5,000,000 |
Increased by $3m |
|
Share Premium Account |
- |
Decreased by $1m |
|
Revaluation Reserve |
1,500,000 |
Unchanged |
|
Retained Profits |
3,000,000 |
Decreased by $2m |
|
|
9,500,000 |
Unchanged |
Advantages
- Cash-starved companies can issue bonus shares instead of cash dividends to provide temporary relief to shareholders.
- Issuing bonus shares improves the perception of company’s size by increasing the issued share capital of the company.
- When distributable reserves (e.g. un-appropriated profits) are used to account for a bonus issue, it decreases the risk to creditors as it reduces the amount of reserves available for distribution to the shareholders of the company.
Disadvantages
- It is not a meaningful alternative to cash dividends for shareholders as selling the bonus shares to meet liquidity requirements would lower their percentage stake in the company.
- Bonus issue does not generate cash for the company.
- As bonus shares increase the issued share capital of the company without any cash consideration to the company, it could cause a decline in the dividends per share in the future which may not be interpreted rationally by all market participants.