Bonus Issue & Rights Issue

Bonus Issue

A bonus issue is a free issue of shares to the existing ordinary shareholders in proportion to their present shareholdings. Bonus issue is made when a company makes profit but does not have sufficient cash to pay dividends. It is made when issued share capital does not adequately represent the long-term capital of the company. Bonus issue involves an increase in ordinary share capital and a reduction in reserves. It increases the total number of shares but does not affect the shareholders equity of the company. To keep reserves in most flexible form, bonus issue is made out of capital reserves first, then revenue reserve. 

Note

Revaluation reserve must not be used for the purpose of bonus issue.

Advantages

1. Bonus issue allows the company to declare a dividend without using up cash
2. Increases capital without diluting current shareholders' holdings
3. Bonus issue is less expensive than rights issue and prospectus issue.
4. Shareholders have an option to convert the shares into cash.
5. It enables the company to liquidate capital reserve that cannot be used for payment of dividend
6. It helps in developing worthy relations of a company with its shareholders

Disadvantages

1. Market value of shares may fall if rate of dividend fluctuates.
2. bonus issue does not raise any cash
3. It could jeopardize payment of future dividends if profits fall
4. the administration costs of the issue might be high in comparison to its benefits

Example

A company currently has the following capital and reserves

A bonus issue of 1 share for every 5 shares was made. The reserves were kept in the most flexible form.

Bonus Issue = 1 / 5 * 500 000 = 100 000

Rights Issue

A rights issue is similar in process to an issue to the general public. Through rights issue, company gives a right to its existing ordinary shareholders to buy more shares from the company at a price which is usually below current market price. In case of rights issue, the existing ordinary shareholders are allowed to purchase the additional shares in proportion to their present shareholdings. Rights issue is a source of funds for the company as it receives cash from their existing shareholders. Therefore, rights issue increases the net assets of a company.

Advantages

1. Existing shareholders may retain control of the company
2. Raises cash for the company
3. Keeps reserves available for future dividends
4. Beneficial for existing shareholders as it is made at a discount to the current market price

Disadvantages

1. It dilutes shareholders' holdings if they do not take up rights issue
2. May not be taken up by the existing shareholders as they may not have the money available to pay for the rights, or have better investment opportunities elsewhere
3. May result in reduction in market value of shares

Example

A company currently has the following capital and reserves

A rights issue of 1 share for every 6 shares was made at $ 1.20.

Rights Issue = 1 / 6 * 300 000 = 50 000 shares

Nominal = 50 000 shares * $ 1 = $ 50 000

Premium = 50 000 shares * $ 0.20 = $ 10 000