Accounting for Bonus and Right Issue—FAQs

• Bonus issue is also known as capitalisation of profits/reserves. It is the free distribution of shares to the existing shareholders. Only free reserve & profits, share premium received in cash & Capital Redemption Reserve can be utilised for issuing fully paid Bonus Shares. Capital reserve realised in cash can also be utilised for bonus issue. However, Revaluation reserve cannot be utilised, since it is not realised in cash.
• Further, once the decision to make bonus issue is made, it cannot be withdrawn.
• As per section 63(1) of Companies Act, 2013, company may issue fully paid up bonus shares to its members, out of:

1. 1. Its free reserves (as per section 2 (43) free reserves means reserves available for  distribution as dividend as per latest audited balance sheet.)
   2. The securities premium account [sec. 52(2)] or
   3. The capital redemption reserve account [sec. 55(4)]
   4. Revaluation reserve cannot be used.

• As per section 63(2) Bonus issue shall be allowed if:

1. 1. It is authorised by articles,
   2. Recommended by board & authorised in general meeting,
   3. The company has not defaulted in payment of interest or principal of fixed deposit or debt securities, payment of statutory dues of employees like PF, Gratuity, Bonus etc.
   4. Partly paid-up shares, if any, are made fully paid up, before bonus issue.
   5. The company shall comply with other conditions as may be prescribed.

• As per Section 63(3) Bonus issue shall not be in lieu of dividend.
• As per Article 39 of table ‘F’ under schedule I a company can resolve to use free reserves & surplus for:

• • Converting partly paid share into fully paid share by bonus or
  • Issuing fully paid bonus shares
  • To members who would have been entitled thereto, if distributed by way of dividend and in the same proportions.

Any company, public or private, intending to raise its subscribed share capital by way of issue of further shares is governed by the provisions of Section 62(1)(a) of the Companies Act, 2013. Whenever a company decides to issue new shares to the outsiders, dilution occurs in respect of the voting rights as well as the earning per share of the existing shareholders. In order to preserve the rights & the position of the existing shareholders, Companies Act, 2013 provides for the offer of Right Shares through a letter of offer to the shareholders in proportion to their existing shareholding. The existing shareholders are given an option to subscribe these shares, if they like, at the first instance. The shareholders are also given the right to renounce this right wholly or partially in favour of some other person provided the right to renounce is not prohibited by articles of the company. Thus, right issue is a preemptive right that is given to an existing shareholder in preference to an outsider. When the right issue offer is availed by an existing shareholder the value of right is determined as given below:

Value of Right = Cum-right value of the share Ex-right value of the share

Advantages of Right Issue are as follows:

1. Right shares ensure reduction in dilution of financial and governance rights of existing shareholders & maintain their proportional holding in the company.
2. It is a cost-effective way of raising capital since issue of prospectus is not required.
3. Right issue is a better method of raising capital than a public issue since it is logistically much easier to handle.
4. The additional shares can be acquired by the existing shareholders at a lesser (discounted) price than the market price of the existing shares.

Disadvantages of Right Issue are as follows:

Despite the considerable advantages offered by the right issue, it invariably leads to dilution in the market value of the shares of the company and has following disadvantages:

1. It results in decrease in Earning Per Share.
2. If the shareholders renounce the right shares, it results in dilution of their rights.
3. Limited amount of funds can be raised as capital by way of right shares depending on the existing equity value of the firm as prescribed by SEBI.
4. A right issue by a company is often viewed suspiciously by the shareholders as a precursor to negative trends.