Tag: Investment Accounting

The issuance of shares by a company is one of the most common ways of raising capital. Companies can issue shares in different ways, such as initial public offerings (IPOs), private placements, and rights issues. Two other types of share issuance are bonus issues and bonus shares. Rights issue and bonus issue are two different ways of issuing shares by a company. A rights issue is a way for a company to raise additional capital by offering existing shareholders the right to buy new shares at a discounted price, while a bonus issue is a way to reward existing shareholders by issuing additional shares without raising any new capital. Both types of issues have their own advantages and disadvantages and should be carefully evaluated by the company before making a decision. It is important for investors to understand the implications of these issues before making any investment decisions.

Rights Issue of Shares:

A rights issue is a way for a company to raise additional capital by offering existing shareholders the right to buy new shares in proportion to their current holdings. The company offers the new shares at a discount to the current market price, making it an attractive option for existing shareholders. The rights issue is a type of public offering, but only existing shareholders can participate.

For example, if a company has 10 million shares outstanding and decides to issue 1 million new shares through a rights issue, it will offer one right to every ten shares held by existing shareholders. If a shareholder holds 1,000 shares, he or she will be offered 100 rights to purchase 100 new shares at a discounted price. The rights issue is usually offered for a limited period of time, and shareholders can choose to exercise their rights or sell them to other investors in the market.

Process of Rights Issue of Shares

• Announcement:

The first step in a rights issue is the announcement by the company to its shareholders and the general public. The announcement includes details about the number of shares to be issued, the price at which they will be offered, and the time period during which shareholders can exercise their rights.

• Record Date:

The company then fixes a record date, which is the date on which shareholders must hold the shares to be eligible for the rights issue. Shareholders who purchase shares after the record date are not eligible for the rights issue.

• Issue of Rights:

Once the record date is fixed, the company issues the rights to existing shareholders based on the number of shares they hold. The rights are issued in proportion to the existing shareholding, and each right gives the shareholder the option to purchase a specified number of new shares at a discounted price.

• Trading of Rights:

Shareholders can either exercise their rights or sell them in the market. The rights can be traded like regular shares, and their value is determined by the difference between the market price and the discounted price of the new shares.

• Exercise of Rights:

Shareholders who wish to exercise their rights must submit an application and payment for the new shares before the expiration of the rights issue period. The payment must be made at the discounted price specified in the rights issue announcement.

• Allotment of Shares:

After the expiration of the rights issue period, the company determines the total number of shares applied for and allot the new shares to the applicants. If there is an oversubscription, the company may allocate the shares on a pro-rata basis.

• Listing:

The new shares issued through the rights issue are listed on the stock exchange, and existing shareholders who have exercised their rights can trade them in the market.

Benefits of Rights Issue of Shares

• Capital Raising:

Rights issue is a quick and cost-effective way for a company to raise additional capital from its existing shareholders without incurring any underwriting or brokerage fees.

• Dilution:

Rights issue does not result in dilution of ownership for existing shareholders since they have the option to purchase new shares in proportion to their current holdings.

• Support:

Rights issue is usually offered at a discount to the market price, making it an attractive option for existing shareholders. It also shows the company’s commitment to its existing shareholders and provides a way for them to support the company’s growth plans.

Bonus Issue of Shares

Bonus issue is a way for a company to reward its existing shareholders by issuing additional shares without raising any new capital. The bonus shares are issued to existing shareholders in proportion to their current holdings. For example, if a company issues a 1:1 bonus issue, each shareholder will receive one additional share for every share they hold.

Process of Bonus Issue of Shares

• Announcement:

The first step in a bonus issue is the announcement by the company to its shareholders and the general public. The announcement includes details about the number of shares to be issued, the ratio of the bonus issue, and the time period during which the bonus shares will be credited to shareholders’ accounts.

• Record Date:

The company then fixes a record date, which is the date on which shareholders must hold the shares to be eligible for the bonus issue. Shareholders who purchase shares after the record date are not eligible for the bonus issue.

• Allotment of Shares:

After the record date, the company credits the bonus shares to the eligible shareholders’ accounts in proportion to their current holdings. The bonus shares are usually credited within a few weeks after the record date.

• Listing:

The bonus shares are listed on the stock exchange, and existing shareholders can trade them in the market.

Benefits of Bonus Issue of Shares

• Rewarding Shareholders:

Bonus issue is a way for a company to reward its existing shareholders without raising any new capital. It shows the company’s commitment to its shareholders and provides a way to retain them.

• Increase in Liquidity:

Bonus issue increases the liquidity of the company’s shares as the number of shares outstanding increases. This can result in higher trading volumes and better price discovery in the market.

• Positive Signal:

Bonus issue is usually viewed as a positive signal by the market as it indicates that the company is in a strong financial position and expects to continue to perform well in the future.

Key differences between Rights Issue and Bonus Issue:

Feature	Rights issue	Bonus issue
Purpose	To raise additional capital	To reward existing shareholders
Eligibility	Only existing shareholders are eligible	Only existing shareholders are eligible
Discounted Price	Offered at a discounted price	No discounted price
Capital Raised	Raises additional capital for the company	No additional capital raised
Dilution of Ownership	May result in dilution of ownership for shareholders	No dilution of ownership
Listing of New Shares	New shares are listed on the stock exchange	New shares are listed on the stock exchange
Market Perception	May be viewed as a negative signal by the market	Usually viewed as a positive signal by the market

Bonus issues are funded through a company’s internal reserves rather than fresh capital. The primary sources include Accumulated profits, Free reserves, and the Securities premium account. Accumulated profits represent retained earnings available for capitalization. Free reserves consist of surplus funds not earmarked for liabilities, ensuring financial stability. The securities premium account includes excess amounts received from share issuances, which can be used under Section 52 of the Companies Act, 2013. These sources enable companies to issue bonus shares without affecting cash flow while enhancing shareholder value and market liquidity.

Sources of Financing Bonus Issues:

1. Accumulated Profits

Accumulated profits refer to the retained earnings that a company has generated over time after paying dividends and other obligations. These profits are reinvested into the business and can be capitalized to issue bonus shares. Using accumulated profits for a bonus issue allows a company to reward shareholders without impacting cash reserves. It enhances investor confidence and portrays financial stability. However, since these profits are already accounted for within the equity section, issuing bonus shares does not provide additional funds but improves share liquidity. The Companies Act, 2013, allows companies to capitalize a portion of their accumulated profits to issue bonus shares, subject to regulatory approvals and compliance with financial norms.

2. Free Reserves

Free reserves consist of the profits available for distribution, which are not earmarked for specific liabilities. These reserves arise from a company’s surplus earnings and are often allocated toward growth, dividend payouts, or bonus issues. Capitalizing free reserves for bonus issues increases share capital while maintaining overall equity. It benefits shareholders by enhancing their investment value without diluting ownership. Companies must ensure that the reserves used for the bonus issue are truly free and not encumbered by liabilities. SEBI and the Companies Act, 2013, regulate the usage of free reserves for issuing bonus shares, ensuring transparency and financial prudence.

3. Securities Premium Account

The securities premium account consists of the extra amount received over the nominal value of shares issued at a premium. Companies can use this premium to finance bonus issues, as per Section 52 of the Companies Act, 2013. Utilizing the securities premium for a bonus issue helps capitalize on excess funds received from shareholders, enhancing the company’s shareholding structure without impacting its operational liquidity. This method reduces the per-share value, making shares more affordable to investors while increasing market activity. However, companies must follow SEBI guidelines and legal provisions ensuring fair utilization.

Bonus issues refer to the distribution of additional shares to existing shareholders at no extra cost, based on their current holdings. These shares are issued from a company’s free reserves or securities premium, converting retained earnings into share capital. Bonus issues increase the total number of shares while keeping the proportionate ownership unchanged. They enhance market liquidity, investor confidence, and perceived financial strength without affecting the company’s cash reserves. However, the market price per share adjusts downward post-issue. Bonus issues are governed by SEBI guidelines and the Companies Act, 2013 in India.

Types of Bonus Issues:

1. Capitalization of Reserves (Bonus Shares from Reserves)

Capitalization of reserves refers to the process where a company converts its accumulated reserves into share capital and issues bonus shares to existing shareholders. Instead of distributing cash dividends, the company allocates additional shares to shareholders in proportion to their existing holdings. These reserves may include free reserves, securities premium reserves, or capital redemption reserves, but not revaluation reserves.

The advantage of this approach is that it enhances investor confidence while maintaining liquidity within the company. By issuing bonus shares, the company increases its share capital without affecting cash flow. However, since bonus shares do not bring additional funds into the company, they do not improve financial strength directly. The market price of shares generally adjusts downward after a bonus issue, ensuring that shareholders’ wealth remains unchanged.

Companies opt for capitalization of reserves when they wish to reward shareholders, improve liquidity, or maintain an investor-friendly image while retaining earnings for future expansion.

2. Bonus Issues out of Free Reserves vs. Capital Reserves

Bonus shares can be issued from free reserves or capital reserves, each having distinct characteristics.

• Bonus from Free Reserves: Companies commonly issue bonus shares from free reserves, retained earnings, or securities premium. These reserves represent accumulated profits, making them ideal for rewarding shareholders. Since these are earned profits, SEBI permits issuing bonus shares from them. It reflects a company’s strong financial performance and long-term stability.

• Bonus from Capital Reserves: Capital reserves arise from non-operating profits, such as asset revaluation or government grants. SEBI restricts issuing bonus shares from revaluation reserves, as they do not represent real earnings. Companies can issue from capital redemption reserves, which arise when preference shares are redeemed.

Securities and Exchange Board of India (SEBI) regulates the issuance of bonus shares to ensure fair practices, protect investors’ interests, and maintain market stability. SEBI has established guidelines for companies issuing bonus shares under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations). These guidelines ensure transparency, fair treatment of shareholders, and prevent price manipulation.

Eligibility Criteria for Issuing Bonus Shares

SEBI mandates that companies must meet certain eligibility criteria before issuing bonus shares.

• The company must ensure that its reserves are sufficient for the bonus issue without affecting its financial stability.

• The company must not have defaulted on any statutory payments, including loans, deposits, or interest on outstanding debt.

• It must not have defaulted in the payment of dues to employees, statutory bodies, or financial institutions.

• The bonus issue must be authorized by the company’s Articles of Association (AOA).

These criteria ensure that only financially stable companies issue bonus shares.

Conditions for Issuing Bonus Shares

SEBI has set specific conditions that companies must comply with while issuing bonus shares.

• The issue must be fully paid-up shares and not convertible into any other form of security.

• The company must ensure that bonus shares are issued out of free reserves, capital redemption reserves, or securities premium accounts.

• The company should not have any outstanding convertible debt instruments at the time of issuing bonus shares.

• The company must ensure that the bonus issue does not dilute its financial position or create undue price fluctuations.

These conditions ensure the fairness and authenticity of bonus share issuance.

Approval Process for Bonus Issues

The issuance of bonus shares requires approval from the company’s board and shareholders.

• The company’s board of directors must first approve the bonus issue in a meeting.

• After board approval, the company must obtain shareholder approval in a general meeting through an ordinary resolution.

• If the Articles of Association (AOA) do not permit bonus issues, the company must amend the AOA before proceeding.

• The company must inform stock exchanges about the approval and proposed record date for the bonus issue.

This process ensures transparency and compliance with legal formalities.

Record Date and Trading Restrictions

SEBI mandates that companies must set a record date for determining eligible shareholders.

• The record date is the cut-off date on which shareholders must hold shares to be eligible for the bonus issue.

• The company must notify stock exchanges at least two working days before the record date.

• After the record date, the shares are traded ex-bonus, meaning new buyers will not receive the bonus shares.

• The bonus shares must be credited to eligible shareholders within 15 days from the record date.

This ensures clarity for investors and prevents market manipulation.

Disclosure and Regulatory Filings:

SEBI requires companies to make necessary disclosures and filings related to bonus issues.

• Companies must file an intimation to stock exchanges about the proposed bonus issue and record date.

• The company must disclose the rationale, impact on financials, and details of the reserves utilized.

• Any material changes or delays in the bonus issue must be promptly reported to SEBI and stock exchanges.

• Companies must publish press releases and investor notifications about the bonus issue.

These disclosures maintain transparency and ensure that investors have accurate information.

Restrictions on Bonus Issues:

SEBI imposes certain restrictions to prevent the misuse of bonus issues.

• Companies cannot withdraw or modify a bonus issue after it is announced.

• Bonus shares must be issued only from free reserves and not from revaluation reserves.

• If the company has defaulted on loans or interest payments, it cannot issue bonus shares.

• Companies must not issue bonus shares to promoters selectively; all shareholders must be treated equally.

These restrictions prevent misuse of bonus issues and ensure fair treatment for all shareholders.

Listing and Trading of Bonus Shares:

Bonus shares must be listed and made tradable as per SEBI regulations.

• The company must list the bonus shares on stock exchanges within two months from the date of approval.

• The shares must be credited to shareholders’ demat accounts before trading begins.

• Companies must ensure that the bonus shares carry the same rights as the original shares.

• The trading price adjusts automatically to reflect the increased number of shares in the market.

This ensures smooth market operations and liquidity for investors.

Impact of Bonus Issues on Stock Prices:

SEBI ensures that bonus issues do not lead to artificial price manipulation in the stock market.

• Stock prices typically adjust after a bonus issue due to increased supply.

• SEBI monitors price movements to prevent suspicious trading activities before or after the bonus announcement.

• Companies must disclose the bonus issue plan in advance to prevent insider trading.

• The impact of bonus issues on a company’s financial performance must be explained in investor reports.

This ensures that bonus issues do not cause unnecessary volatility in the stock market.

Tax Implications of Bonus Issues:

SEBI does not directly regulate taxation, but companies must consider tax implications while issuing bonus shares.

• Bonus shares are not taxable at the time of issuance in the hands of shareholders.

• However, when sold, capital gains tax applies on the selling price minus the original purchase price.

• SEBI requires companies to disclose any tax implications in their investor communications.

• Shareholders must maintain proper records to calculate capital gains tax on future sales.

Understanding tax implications helps investors make informed financial decisions.

Penalties for Non-Compliance with SEBI Guidelines:

SEBI imposes strict penalties for companies that violate bonus issue regulations.

• Companies failing to comply with SEBI guidelines may face fines, trading suspensions, or legal actions.

• If companies delay the issuance of bonus shares beyond the prescribed time, SEBI can impose penalties.

• Shareholders can file complaints with SEBI if they face unfair practices related to bonus issues.

• Stock exchanges monitor compliance and report any violations to SEBI for further action.

These penalties ensure that companies follow fair and ethical practices in issuing bonus shares.

The Companies Act, 2013 governs corporate regulations in India and establishes the legal framework for the incorporation, management, and operations of companies. It aims to enhance corporate governance, transparency, and compliance while protecting stakeholders’ interests. Below are key legal provisions under the Act, categorized by their relevance.

Incorporation and Registration of Companies (Sections 3 to 22):

The Companies Act, 2013 provides the legal foundation for the formation and registration of companies.

• Types of Companies: The Act recognizes public, private, and one-person companies (Section 2).

• Memorandum & Articles of Association (MOA & AOA): Companies must draft and file these documents during incorporation.

• Certificate of Incorporation: Issued by the Registrar of Companies (RoC) as proof of existence.

• Corporate Identity Number (CIN): Every registered company receives a unique CIN.

These provisions ensure that companies operate with a clear legal identity and defined structure.

Corporate Governance and Board of Directors (Sections 149 to 178)

The Act emphasizes strong corporate governance to ensure ethical and efficient business operations.

• Board Composition (Section 149):

  • A listed company must have at least one-third independent directors.

  • At least one woman director is required in certain companies.

• Duties of Directors (Section 166):

Directors must act in good faith and in the best interest of the company and stakeholders.

• Audit Committee (Section 177):

Mandatory for large companies to oversee financial reporting and compliance.

These provisions safeguard transparency and accountability in corporate decision-making.

Share Capital and Securities (Sections 43 to 72)

The Act defines regulations for issuing shares and securities to protect investors.

• Types of Share Capital (Section 43):

Equity shares and preference shares are the primary categories.

• Issue of Shares (Section 62):

Companies can issue rights shares, bonus shares, and preferential allotments.

• Buyback of Shares (Section 68):

A company may repurchase its shares under specific conditions, subject to a 25% limit of its paid-up capital.

• Transfer and Transmission of Shares (Section 56):

The process must be documented and comply with statutory requirements.

These provisions regulate capital structure and protect shareholders’ rights.

Financial Statements, Audit, and Disclosures (Sections 128 to 138):

To ensure financial transparency, companies must maintain proper accounting records and undergo regular audits.

• Books of Accounts (Section 128):

Companies must maintain books at their registered office.

• Statutory Audit (Section 139):

Every company, except a few small firms, must appoint an independent auditor.

• Board’s Report (Section 134):

Includes financial performance, corporate social responsibility (CSR), and risk management details.

• Internal Audit (Section 138):

Required for large and listed companies to strengthen financial control mechanisms.

These provisions ensure accurate financial reporting and prevent fraudulent activities.

Mergers, Acquisitions, and Corporate Restructuring (Sections 230 to 240)

The Act provides a structured framework for corporate restructuring, ensuring legal compliance.

• Compromise and Arrangements (Section 230):

Companies can enter into agreements with creditors and shareholders for restructuring.

• Mergers and Amalgamations (Section 232):

Court or tribunal approval is required for mergers.

• Takeovers and Oppression (Section 241):

Shareholders can seek legal remedies against oppressive management practices.

These provisions facilitate smooth business restructuring while protecting stakeholders’ rights.

Corporate Social Responsibility (CSR) (Section 135)

CSR is a mandatory provision under the Companies Act, 2013, ensuring that businesses contribute to societal development.

• Applicability:

Companies with a net worth of ₹500 crores, a turnover of ₹1000 crores, or a net profit of ₹5 crores must spend 2% of their average net profits on CSR activities.

• CSR Committee:

Companies must form a CSR Committee to oversee and implement projects in education, healthcare, and environmental sustainability.

This provision encourages ethical corporate practices and social welfare initiatives.

Investor Protection and Shareholder Rights (Sections 91 to 127)

To ensure fairness in corporate dealings, the Act provides multiple safeguards for shareholders.

• Annual General Meeting (AGM) (Section 96):

Every company, except one-person companies, must hold an AGM annually.

• Voting Rights (Section 47):

Shareholders have proportional voting rights based on their equity holdings.

• Declaration of Dividends (Section 123):

Dividends must be declared from company profits and transferred to shareholders.

• Unpaid Dividend (Section 124):

Unclaimed dividends must be transferred to the Investor Education and Protection Fund (IEPF).

These provisions ensure transparency and safeguard shareholders’ interests.

Winding Up and Liquidation of Companies (Sections 270 to 365)

The Act defines the legal process for closing a company.

• Voluntary Winding Up (Section 304):

Companies can dissolve voluntarily if shareholders approve.

• Compulsory Winding Up (Section 271):

Ordered by the tribunal due to insolvency, fraud, or non-compliance with regulations.

• Insolvency and Bankruptcy Code (IBC):

The IBC governs financial distress resolution for companies.

These provisions ensure a structured and fair exit strategy for failing businesses.

Issuing bonus shares has benefits and drawbacks for both the company and its shareholders.

For the Company

Advantages of Issuing Bonus Shares

• Capitalization of Reserves

Bonus shares allow the company to convert accumulated profits and reserves into share capital without any cash outflow. This strengthens the company’s financial position while maintaining liquidity.

• Improves Market Perception

Issuing bonus shares signals strong financial health and growth potential, boosting investor confidence and attracting new investors to the company’s stock.

• Increases Share Liquidity

By increasing the number of outstanding shares, bonus issues improve market liquidity, making shares more tradable and reducing price volatility.

• Reduces Dividend Payment Obligation

Instead of paying cash dividends, companies can issue bonus shares, helping conserve cash for future investments, expansion, or debt reduction.

• Enhances Shareholder Loyalty

Bonus shares reward long-term shareholders, encouraging them to hold onto their investments and reducing short-term speculation in the stock.

• Compliance with Regulatory Requirements

Bonus issues can help companies meet statutory requirements related to minimum share capital, making it easier to comply with stock exchange regulations.

Disadvantages of Issuing Bonus Shares:

• No Inflow of Fresh Capital

Unlike a rights issue, a bonus issue does not bring in any new funds, limiting the company’s ability to finance new projects or expansions.

• Increased Administrative Costs

The company incurs additional administrative and compliance costs related to issuing and managing bonus shares, including regulatory filings and shareholder communication.

• Dilution of Earnings Per Share (EPS)

Since the number of outstanding shares increases, the EPS decreases proportionally, which may make the company appear less profitable in the short term.

• Market Misinterpretation

If investors fail to understand that bonus shares do not increase total value, they may expect higher dividends, leading to market misinterpretation and temporary stock price fluctuations.

• Legal and Regulatory Compliance

Issuing bonus shares requires compliance with corporate laws, SEBI guidelines, and stock exchange regulations, which may involve complex approvals and processes.

• No Direct Benefit to the Company

Since bonus shares are issued at no cost to shareholders, the company does not gain any immediate financial benefit, unlike raising funds through a public or rights issue.

For the Shareholders

Advantages of Issuing Bonus Shares

• Free Additional Shares

Shareholders receive additional shares without any cost, increasing their overall holdings in the company proportionally.

• Enhanced Market Liquidity

An increase in the number of shares improves liquidity, making it easier for shareholders to trade their shares at stable prices.

• No Immediate Tax Burden

Unlike cash dividends, bonus shares do not create an immediate tax liability, as they are taxed only when sold, providing tax efficiency.

• Long-Term Wealth Appreciation

Bonus shares provide an opportunity for long-term capital appreciation as share value may increase over time with company growth.

• Increased Dividend Potential in the Future

Even though the current dividend per share may decrease, as the company grows, future dividends on a higher number of shares could increase overall returns.

• Encourages Long-Term Investment

Bonus shares encourage shareholders to hold onto their investments for a longer period, reducing market speculation and promoting steady growth.

Disadvantages of Issuing Bonus Shares:

• No Immediate Monetary Benefit

Unlike cash dividends, bonus shares do not provide an immediate financial return, making them less attractive for investors seeking income.

• Dilution of Earnings Per Share (EPS)

As the number of shares increases, EPS declines, which might lower the stock price in the short term and reduce perceived profitability.

• Market Price Adjustment

Since stock prices generally adjust downward after a bonus issue, shareholders may not see immediate gains despite receiving additional shares.

• Lower Per-Share Dividend

If the company maintains the same total dividend payout, each share receives a lower dividend, affecting shareholders who rely on dividend income.

• No Guarantee of Future Profitability

Receiving additional shares does not guarantee increased returns, as future performance depends on the company’s profitability and market conditions.

• Increased Holding Complexity

With more shares in their portfolio, shareholders may find it harder to manage their investments, especially when tracking price changes and making future investment decisions.

Bonus Shares are additional shares issued by a company to its existing shareholders free of cost, in proportion to their current holdings. Companies issue bonus shares for several strategic and financial reasons.

• Capitalization of Reserves

A company accumulates substantial reserves over time through retained earnings. Instead of distributing these reserves as cash dividends, the company can convert them into share capital by issuing bonus shares. This strengthens the company’s financial position and utilizes idle reserves effectively. By doing so, the company maintains its liquidity while rewarding shareholders. This also prevents excessive accumulation of profits, ensuring that earnings are productively reinvested. Additionally, it demonstrates financial stability, which enhances investor confidence in the company’s long-term sustainability and profitability.

• Enhancing Market Perception

Issuing bonus shares can improve investor confidence and create a positive perception of the company in the stock market. When a company distributes bonus shares, it signals strong financial health and growth potential. This action increases investor trust and can attract new investors, leading to an overall improvement in the company’s stock valuation. The increase in issued capital without any cash outflow reflects the company’s profitability, reinforcing its reputation. Moreover, regular bonus issues indicate consistent performance, encouraging long-term investments from shareholders and institutional investors.

• Increasing Liquidity of Shares

Bonus shares help increase the number of outstanding shares in the market, improving the stock’s liquidity. Higher liquidity ensures that shares can be easily bought and sold, reducing volatility and making the stock more attractive to investors. This benefits shareholders, as increased liquidity leads to better price discovery and reduces the impact of large trades on stock prices. Moreover, enhanced liquidity can attract institutional investors and traders, resulting in a more active market for the company’s shares. Over time, this increased trading volume can contribute to a more stable stock price.

• Making Shares More Affordable

The price of a company’s shares may become too high, making them less accessible to retail investors. Issuing bonus shares reduces the per-share price while maintaining the total value of an investor’s holdings. This affordability increases demand, attracting small and retail investors who previously found the stock expensive. A lower share price also enhances market participation, leading to greater trading activity. Furthermore, this strategy helps maintain a broad shareholder base, ensuring that ownership is not concentrated among a few large investors, which contributes to better corporate governance.

• Rewarding Long-Term Shareholders

Bonus shares serve as a reward for loyal, long-term shareholders. Since they are issued free of cost, existing investors benefit without having to invest additional capital. This increases investor satisfaction and encourages long-term holding, reducing frequent stock trading and stabilizing the shareholder base. Long-term investors gain additional shares proportionate to their existing holdings, increasing their total investment value. Additionally, rewarding shareholders in this way strengthens investor relations and reinforces their confidence in the company’s ability to generate consistent profits over time.

• Reducing Dividend Payout Pressure

If a company prefers to retain cash for expansion, debt repayment, or other operational needs, issuing bonus shares can be an alternative to cash dividends. Instead of distributing profits as cash, the company converts them into additional shares, ensuring that reserves are effectively utilized without impacting cash flow. This strategy allows companies to maintain financial flexibility while still rewarding shareholders. It also reduces the company’s immediate tax burden and helps maintain liquidity for future investments. For shareholders, bonus shares represent a long-term value gain, as they may appreciate over time.

• Compliance with Regulatory Requirements

Certain financial regulations or stock exchange requirements mandate that companies maintain a minimum share capital. Issuing bonus shares helps a company meet these regulatory standards without raising new funds from external investors. This ensures compliance while avoiding dilution of existing shareholders’ stakes. Additionally, it helps companies strengthen their balance sheets, which may be necessary for securing loans or expanding business operations. Compliance with regulatory norms also enhances the company’s reputation, signaling to investors and stakeholders that the company is financially sound and well-managed.

• Improving Earnings per Share (EPS) Stability

Bonus shares help maintain earnings per share (EPS) stability over time by distributing profits efficiently among shareholders. While the total earnings remain unchanged, the per-share earnings may decrease temporarily due to an increase in outstanding shares. However, as the company continues to grow, EPS improves, benefiting shareholders in the long run. Moreover, stable EPS figures make a company’s financial performance appear consistent, which can positively influence investor confidence. Over time, a strong EPS trend can result in a higher stock valuation and better financial credibility in the market.

The buyback of shares is an important financial decision that reduces a company’s equity share capital and impacts its reserves and liquidity. The Companies Act, 2013 (Section 68) and Accounting Standards (AS) govern the buyback process in India. The company must ensure that it follows proper accounting treatment while recording buyback transactions.

Step-by-Step Accounting Treatment of Buyback:

The following journal entries are recorded for buyback transactions:

Step	Transaction	Journal Entry	Debit (Dr.)	Credit (Cr.)
1	Transfer to Buyback Account (To ensure funds are set aside for buyback)	Buyback of Equity Shares A/c Dr. To Bank A/c	Buyback of Equity Shares A/c ₹XXX	Bank A/c ₹XXX
2	Cancellation of Share Capital (Reduction in equity capital after buyback)	Equity Share Capital A/c Dr. To Equity Shares Buyback A/c	Equity Share Capital A/c ₹XXX	Equity Shares Buyback A/c ₹XXX
3	Premium on Buyback (if applicable) (If buyback price is higher than face value, adjust the excess amount from Securities Premium/Free Reserves)	Securities Premium A/c Dr. General Reserve A/c Dr. To Equity Shares Buyback A/c	Securities Premium A/c ₹XXX General Reserve A/c ₹XXX	Equity Shares Buyback A/c ₹XXX
4	Transfer to Capital Redemption Reserve (CRR) (As per the Companies Act, the nominal value of shares bought back must be transferred to CRR)	General Reserve A/c Dr. To Capital Redemption Reserve A/c	General Reserve A/c ₹XXX	Capital Redemption Reserve A/c ₹XXX
5	Payment to Shareholders (Final payment for the buyback)	Equity Shares Buyback A/c Dr. To Bank A/c	Equity Shares Buyback A/c ₹XXX	Bank A/c ₹XXX

illustration with Example

Let’s assume XYZ Ltd. decides to buy back 10,000 equity shares of ₹10 face value at ₹50 per share using free reserves.

Step 1: Identify Key Values

Particulars	Amount (₹)
Number of shares bought back	10,000
Face value per share	₹10
Buyback price per share	₹50
Total Buyback Cost (10,000 × ₹50)	₹5,00,000
Nominal Value of Shares (10,000 × ₹10)	₹1,00,000
Premium Paid on Buyback (10,000 × ₹40)	₹4,00,000

Step 2: Pass Accounting Entries

1. Transfer Buyback Amount to a Separate Account

Journal Entry
Buyback of Equity Shares A/c Dr. ₹5,00,000
To Bank A/c ₹5,00,000
(Being amount transferred to buyback account for repurchase of shares)

2. Cancellation of Equity Share Capital

Journal Entry
Equity Share Capital A/c Dr. ₹1,00,000
To Equity Shares Buyback A/c ₹1,00,000
(Being cancellation of equity share capital for shares repurchased)

3. Adjust Premium Paid on Buyback

Journal Entry
Securities Premium A/c Dr. ₹4,00,000
To Equity Shares Buyback A/c ₹4,00,000
(Being premium on buyback adjusted from securities premium reserves)

4. Transfer Nominal Value to Capital Redemption Reserve (CRR)

Journal Entry
General Reserve A/c Dr. ₹1,00,000
To Capital Redemption Reserve A/c ₹1,00,000
(Being transfer of nominal value of shares bought back to CRR as per Companies Act, 2013)

5. Payment to Shareholders

Journal Entry
Equity Shares Buyback A/c Dr. ₹5,00,000
To Bank A/c ₹5,00,000
(Being payment made to shareholders for buyback of shares)

Effect on Financial Statements:

The buyback of shares affects the company’s financial statements in the following ways:

1. Balance Sheet (Post Buyback)

Particulars	Before Buyback (₹)	After Buyback (₹)
Equity Share Capital	₹10,00,000	₹9,00,000
Securities Premium Reserve	₹8,00,000	₹4,00,000
General Reserve	₹12,00,000	₹11,00,000
Capital Redemption Reserve (CRR)	₹0	₹1,00,000
Bank Balance	₹15,00,000	₹10,00,000

2. Cash Flow Statement

The buyback results in a cash outflow under financing activities of ₹5,00,000.

3. Notes to Accounts

• Buyback of 10,000 equity shares at ₹50 each was completed.

• Capital Redemption Reserve of ₹1,00,000 was created.

• Securities Premium Reserve was reduced by ₹4,00,000.

Direct Negotiation or Targeted Buyback of Shares is a method where a company repurchases its shares directly from specific shareholders instead of offering a general buyback to all. This approach is typically used to buy shares from large investors, promoters, or institutional shareholders who wish to exit their holdings. The price is negotiated between the company and the seller, often at a Premium to the market price. This method allows companies to Regain control, Consolidate ownership, or Eliminate dissenting Shareholders, ensuring strategic benefits while complying with SEBI Buyback Regulations and the Companies Act, 2013.

Characteristics of Direct Negotiation /Targeted Buyback of Shares:

• Selective Shareholder Participation

In a targeted buyback, the company repurchases shares from specific shareholders, such as promoters, institutional investors, or large stakeholders, rather than offering the buyback to all shareholders. This method is useful for removing dissenting investors, consolidating ownership, or regaining control over the company. Unlike open market repurchases, this buyback is not available to the general public, making it a strategic tool for restructuring ownership in a controlled manner.

• Privately Negotiated Price

The price of shares in a direct negotiation buyback is determined through mutual agreement between the company and the selling shareholders. It is often higher than the prevailing market price to incentivize shareholders to sell their stakes. This premium ensures that key investors willingly participate in the buyback, making the process more efficient. However, the company must ensure that the buyback price aligns with regulatory guidelines under the Companies Act, 2013 and SEBI Buyback Regulations.

• Regulatory Compliance and Approvals

The targeted buyback must comply with regulations outlined in the Companies Act, 2013, SEBI Buyback Regulations, and, if applicable, stock exchange listing requirements. The company must obtain necessary board and shareholder approvals before executing the buyback. Additionally, regulatory bodies may require disclosure of the buyback price, purpose, and impact on financial statements to ensure transparency and prevent misuse of funds.

• Reduction in Free Float and Market Impact

Since a targeted buyback involves purchasing shares directly from specific investors, it reduces the number of publicly available shares (free float). This may lead to a rise in the stock price due to a supply-demand imbalance. Unlike open market buybacks, targeted buybacks have less direct impact on daily stock trading, making them a preferred choice when a company wants to avoid excessive market fluctuations.

• Efficient Use of Corporate Resources

Companies often use targeted buybacks to utilize surplus cash efficiently while providing an exit route to select investors. This method allows the company to strengthen financial ratios such as earnings per share (EPS) and return on equity (ROE) by reducing outstanding shares. However, businesses must ensure that buyback funding does not strain financial liquidity or impact future investment plans.

• Strategic Control and Ownership Consolidation

A direct negotiation buyback is commonly used for ownership consolidation, particularly when promoters or major shareholders want to increase their stake. It helps prevent hostile takeovers by limiting external ownership and aligning voting rights with strategic objectives. By selectively purchasing shares, companies can strengthen governance structures and improve decision-making power for core stakeholders.

Components of Direct Negotiation /Targeted Buyback of Shares:

1. Identified Shareholders

In a targeted buyback, the company identifies specific shareholders from whom shares will be repurchased. These may include promoters, institutional investors, venture capitalists, or dissenting stakeholders. Unlike general buybacks, which are open to all shareholders, this method focuses on selected participants to achieve strategic goals like ownership consolidation, removing activist investors, or rewarding long-term investors.

2. Negotiated Price

The buyback price is not determined by market forces but is privately negotiated between the company and the selling shareholders. This price is often higher than the market price to make the offer attractive. The agreed price takes into account factors like book value, earnings potential, and market conditions, ensuring that both parties benefit from the transaction.

3. Board and Shareholder Approval

Since a targeted buyback involves a selective purchase of shares, it requires approval from the Board of Directors and, in some cases, the shareholders. The buyback proposal must outline details such as the number of shares, pricing, funding source, and impact on financial statements. The process is governed by Section 68 of the Companies Act, 2013 and SEBI guidelines.

4. Regulatory Compliance

The buyback must adhere to regulatory requirements, including SEBI Buyback Regulations, Companies Act, 2013, and stock exchange listing norms. The company must ensure that:

• • The buyback does not exceed 25% of the total paid-up equity capital and free reserves.

  • The debt-equity ratio does not exceed 2:1 after the buyback.

  • All disclosures and filings are submitted as per regulations.

5. Funding Mechanism

The buyback is funded through free reserves, securities premium, or proceeds from fresh issue of shares/debentures. Companies cannot use borrowed funds for buybacks. The financial impact must be assessed to ensure that the buyback does not harm the company’s liquidity or investment plans.

6. Impact on Shareholding Structure

Targeted buybacks result in changes in ownership patterns, often leading to higher promoter holding and reduced public float. This can impact stock liquidity and influence stock prices in the long term. Companies must disclose post-buyback shareholding patterns in their regulatory filings.

7. Execution and Settlement

Once approvals are secured, the company executes the buyback as per the agreed terms. Shares are transferred to the company and extinguished, reducing the outstanding share capital. The transaction is settled either through cash or other negotiated terms, ensuring compliance with legal and financial obligations.