What are Bonus Shares?
Bonus shares are additional shares granted to existing shareholders of a company at no extra cost, based on the proportion of shares they already own. This corporate action is often taken from a company’s reserves built from accumulated profits, known as retained earnings or share premium accounts. Bonus shares are also referred to as a scrip issue or capitalization issue. These shares do not generate any immediate wealth for shareholders but increase the number of shares they hold, thus diluting the share price but maintaining overall shareholder value.
Key Features of Bonus Shares
- No Cash Transaction: Issuance of bonus shares requires no cash outflow from shareholders.
- Proportional Distribution: Bonus shares are distributed in a specified ratio (e.g., 1:4, 2:1).
- Adjusts Share Price Mechanically: The share price adjusts in direct proportion to the bonus share ratio, generally falling to account for the increased share count.
- Sign of Confidence: Bonus issues are often viewed as a sign of financial health and confidence in future profitability by company management.
Examples of Bonus Shares
- 1:4 Bonus Issue: If a shareholder holds 4 shares, and the company declares a 1:4 bonus issue, the shareholder will receive one additional share for every four shares held, resulting in a total of 5 shares.
- 2:1 Bonus Issue: If a shareholder holds 1 share, and the company declares a 2:1 bonus issue, the shareholder will receive two additional shares for each share held, resulting in a total of 3 shares.
Frequently Asked Questions (FAQs)
Q1: Why do companies issue bonus shares?
- Companies issue bonus shares to reward shareholders, capitalize retained earnings, and increase the liquidity of shares.
Q2: Do bonus shares affect a shareholder’s percentage ownership?
- No, bonus shares do not affect the percentage ownership of shareholders as they are allotted in a way that keeps the proportionate equity holding unchanged.
Q3: How do bonus shares affect the share price?
- The share price generally falls in proportion to the bonus ratio because the total number of shares increases while overall market capitalization remains the same.
Q4: Are bonus shares taxable?
- In many jurisdictions, the issuance of bonus shares is not a taxable event. However, tax implications on subsequent sale of these shares may vary.
Q5: How do companies view issuing bonus shares?
- Issuing bonus shares is often seen as a sign of strength, suggesting that a company has enough reserves and a positive outlook.
Related Terms
- Shareholding: The ownership stake a shareholder has in a company.
- Scrip Issue: Another term for a bonus issue, where additional shares are issued to shareholders.
- Stock Dividend: Similar to bonus shares, except these typically represent a direct addition to a shareholder’s equity without altering the total share count route.
- Retained Earnings: Profits that the company retains for reinvestment rather than distributing as dividends.
- Share Premium Account: A reserve on a company’s balance sheet representing the amount received for shares exceeding their nominal value during issuance.
Online References
Suggested Books for Further Studies
- “Financial Accounting for Managers” by T.P. Ghosh
- “Financial Management” by Eugene F. Brigham and Michael C. Ehrhardt
- “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
Accounting Basics: “Bonus Shares” Fundamentals Quiz
### What are bonus shares?
- [ ] Shares bought by investors at a discounted rate.
- [x] Additional shares issued to existing shareholders at no extra cost.
- [ ] Shares purchased through an Initial Public Offering (IPO).
- [ ] Shares issued only during stock splits.
> **Explanation:** Bonus shares are additional shares issued to existing shareholders of a company at no extra cost based on the number of shares previously held.
### How does a 1:4 bonus issue affect shareholding?
- [ ] Each shareholder receives an additional four shares for each they owned.
- [ ] The number of shares each shareholder holds decreases.
- [x] Each shareholder receives an additional share for every four shares they owned.
- [ ] The company's share count decreases as a result of issuing bonus shares.
> **Explanation:** In a 1:4 bonus issue, each shareholder receives one additional share for every four shares they hold.
### What is a potential reason for a company to issue bonus shares?
- [x] To reward existing shareholders.
- [ ] To quickly raise additional capital.
- [ ] To reduce the total number of shares outstanding.
- [ ] To reduce the percentage ownership of current shareholders.
> **Explanation:** Issuing bonus shares can reward existing shareholders by increasing the total number of shares they own without requiring any additional investment from them.
### How does a bonus share issue typically affect the company's share price?
- [ ] It increases the share price.
- [ ] The share price remains the same.
- [x] It decreases the share price proportionally.
- [ ] The share price becomes volatile and unpredictable.
> **Explanation:** The issuance of bonus shares generally causes the share price to decrease proportionally since more shares are now available, but the overall market capitalization remains unchanged.
### What is a scrip issue another term for?
- [ ] a buyback program.
- [ ] a stock dividend payout.
- [ ] the cancellation of existing shares.
- [x] the issuance of bonus shares.
> **Explanation:** A scrip issue is another term used to describe the issuance of bonus shares.
### Which account is typically used to issue bonus shares?
- [ ] Sales Revenue
- [ ] Cash Reserves
- [ ] Accounts Receivables
- [x] Share Premium Account
> **Explanation:** Bonus shares are often issued from a company's retained earnings or share premium account.
### Are bonus shares taxable at the time of issuance?
- [x] No, not typically.
- [ ] Yes, always.
- [ ] Only if the shareholder sells them.
- [ ] It depends on the jurisdiction.
> **Explanation:** In many jurisdictions, the issuance of bonus shares is not a taxable event although subsequent sale may be subject to capital gains tax.
### Can a 2:1 bonus issue result in an increased percentage ownership?
- [ ] Yes, because more shares are owned post-issue.
- [x] No, the percentage ownership remains unchanged.
- [ ] Yes, the company is issuing more shares.
- [ ] Percentage ownership decreases as well.
> **Explanation:** The percentage ownership remains unchanged as all shareholders receive bonus shares in proportion to their existing holdings.
### What is one advantage of issuing bonus shares for the company?
- [ ] It helps to decrease the company's perceived share price.
- [ ] It directly injects cash into the company.
- [ ] It helps to dilute the shareholding percentage of large shareholders.
- [x] It reflects the confidence of management in the company's future profitability.
> **Explanation:** Issuing bonus shares is often a sign of management's confidence in the long-term profitability and health of the company.
### Which of the following is true after a bonus issue?
- [x] The shareholder's proportionate ownership remains the same.
- [ ] The shareholder's ownership proportion decreases.
- [ ] The shareholder receives less dividend income.
- [ ] The total number of shares in the company decreases.
> **Explanation:** The shareholder's proportionate ownership in the company remains the same, in line with all other shareholders retaining their relative proportions.
Thank you for exploring the concept of bonus shares and taking on our quiz challenges. Continue advancing your financial and accounting prowess!
