What is a Free Issue (Scrip Issue)?
A free issue, commonly referred to as a scrip issue, is a method used by companies to reward existing shareholders by issuing additional shares at no extra cost. The issuance of these bonus shares is typically proportional to the number of shares already owned by the shareholders. Essentially, it’s a way of distributing excess profits in the form of additional shares rather than cash dividends.
By doing so, the existing share capital is restructured, providing shareholders with more shares, which could potentially result in higher dividends in the future, without any immediate cash outlay from the recipients. This move can also increase the liquidity of the company’s shares in the market.
Examples of Free Issue
Company A: Let’s say Company A decides to issue a free issue on a ratio of 1:5. This indicates that for every 5 shares that a shareholder owns, they will receive 1 additional share for free. If John owns 100 shares, he will receive 20 additional shares (100 / 5).
Company B: Suppose Company B declares a 2:10 scrip issue. This signifies that for every 10 shares a shareholder has, 2 new shares will be issued for free. If Mary has 50 shares, she will receive 10 extra shares (50 / 10 * 2).
Frequently Asked Questions (FAQs)
Q1: Why do companies issue additional shares for free? A: Companies might issue additional shares to reward existing shareholders, increase liquidity, and make their shares more attractive without having to pay cash dividends.
Q2: How does a free issue affect the market price of the shares? A: The market price per share generally decreases proportionally since the number of shares in circulation increases while the company’s market capitalization remains the same.
Q3: Are free issues taxable? A: Depending on the jurisdiction, free issues might not be immediately taxable, but selling the shares in the future might incur capital gains tax.
Q4: What is the difference between a free issue and a stock split? A: In a free issue, shareholders receive additional shares at no cost, increasing the total number of shares they own. In a stock split, the number of shares increases, but the value and equity proportions remain the same, as shares are split into smaller denominations.
Related Terms with Definitions
- Bonus Shares: Shares distributed by a company to its existing shareholders at no extra cost, often synonymous with free issue.
- Rights Issue: A process where companies offer additional shares to existing shareholders at a discounted rate before the shares are offered to the public.
- Stock Split: A corporate action to divide the existing shares into multiple shares to boost liquidity while keeping the market capitalization the same.
- Capitalization Issue: Another term for a free issue, where a company capitalizes its reserves by issuing new shares to shareholders.
Online References
- Investopedia Free Issue
- Corporate Finance Institute: Scrip Issue
- The Balance: What is a Stock Split and How Does it Work
Suggested Books for Further Studies
- “Financial Accounting: An Introduction” by Pauline Weetman - An excellent resource for understanding fundamental and advanced accounting principles.
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen - Offers insights into various corporate finance topics including equity management and corporate actions.
- “Advanced Accounting” by Joe Ben Hoyle, Thomas Schaefer, and Timothy Doupnik - Covers complex accounting practices and equity transactions.
Accounting Basics: “Free Issue” Fundamentals Quiz
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