When the additional shares are allotted to the existing shareholders without receiving any additional payment from them, it is known as issue of bonus shares.
Bonus shares are allotted by capitalizing the reserves and surplus.
Issue of bonus shares results in the conversion of the company's profits into share capital. Therefore it is termed as capitalization of company's profits.
Since such shares are issued to the equity shareholders in proportion to their holdings of equity share capital of the company, a shareholder continues to retain his / her proportionate ownership of the company.
Issue of bonus shares does not affect the total capital structure of the company. It is simply a capitalization of that portion of shareholders' equity which is represented by reserves and surpluses.
It also does not affect the total earnings of the shareholders.
Issue of Bonus Shares is more or less a financial gimmick without any real impact on the wealth of the shareholders. Still firms issue bonus shares and shareholders look forward to issue of bonus shares.
Reasons for issuing Bonus Shares
1. The bonus issue tends to bring the market price per share within a more reasonable range.
2. It increases the number of outstanding shares. This promotes more active trading.
3. The nominal rate of dividend tends to decline. This may dispel the impression of profiteering.
4. Share capital base increases and the company may achieve a more spectacular size in the eyes of the investing company.
5. Shareholders regard a bonus issue as a strong indication that the prospects of the company have brightened and they can reasonably look for an increase in total dividend.
6. It improves the prospects of raising additional funds.
Regulation of Bonus Issues
Important regulatory provisions governing issue of bonus shares are:
1. The bonus issue is made out of free reserves built out of the profits or share premium collected in cash only.
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