Accounting of Bonus Shares

Section 81 of the Companies Act requires that a public limited company, whenever it proposes to increase its subscribed capital after the expiry of two years from the date of its incorporation or after the expiry of one year from the date of allotment of shares in that company, made for the first time after its formation, whichever is earlier, shall be required to offer those shares to the existing equity shareholders in the proportion of paid-up capital as nearly as possible. Such shares are known as rights shares.

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.

The price at which these shares are offered to the existing shareholders is normally below the market price of the shares. The existing shareholders thus have a specific advantage in the sense that market price of the shares offered is more than its issue price. This specific advantage has a money value called as value of the right.

The value of the right can be calculated as follows:

1. Ascertain the total market value of the shares which a shareholder is required to possess in order to get additional shares from of the fresh issue.
2. Add to the above market price, the amount to be paid to the company for additional shares of the fresh issue.
3. Find average price. This can be calculated by dividing the total prices calculated under step 2 by the total number of shares.
4. Deduct average price from market price. This difference is called value of the right.

The accounting entries in each of these cases would be as follows:

(A) For converting partly paid shares into fully paid shares

(i) Equity share final call a/c Dr.

  To equity capital a/c

(Being call money due on … shares)

(ii) P&L a/c Dr.

Securities Premium a/c

Reserve a/c Dr.

  To bonus to shareholders a/c

(Being bonus declared)

(iii) Bonus to shareholders a/c Dr.

  To equity share final call a/c

(Conversion of partly paid equity shares into fully paid equity shares)

(B) For fully paid bonus shares

(i) P&L a/c

Securities Premium a/c

Reserve a/c Dr.

  To bonus to shareholders a/c

(ii) Bonus to shareholders a/c Dr.

  To equity share capital a/c

(Being bonus utilised to issue fully paid up bonus shares)

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

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.

Case 1

When new fully paid up bonus shares are issued

a) for providing amount of bonus

Capital reserve account debit xxxx

share premium account debit xxxx

Capital redemption reserve account debit xxxx

Other general reserve account debit xxxx

Profit and loss account debit xxxx

Bonus to shareholder account credit xxxx

b) for issue of bonus

Bonus to equity shareholder account debit

Equity share capital account credit