What are Bonus Shares?

Introduction

Being a shareholder in a company, your returns are often proportional to the growth trajectory of the business. Interestingly, a company has more ways to reward its long-term investors while leveraging its profits and savings.  

This is where bonus shares come into the picture. 

When companies issue additional shares to the present shareholders at no extra cost, it is defined as bonus shares. They are generally issued to shareholders in the specific ratio of their existing stake in the company.

For example, suppose that a company declares the bonus issue of a 2:1 ratio. Then, each shareholder will receive 2 shares for free for every one share they hold. There isn’t any fixed time to issue bonus shares. A company can opt for a bonus issue to distribute its surplus profit without having to roll it out in the form of dividends. 

Once you are aware of the exact bonus shares meaning, let us understand its types.

Type of Bonus Shares

There are mainly two types of bonus shares based on the cost of each share, as discussed below:

1. Fully Paid Bonus Shares

Fully paid bonus shares are those which are distributed without any extra cost. They are paid in ratio to the present shareholding of shareholders. The company issues this type of bonus shares from: 

• Profit and loss account: Here, the company issues bonus shares from their accumulated profits that had not been distributed as dividends so far. 

• Security premium account: This account holds the amount received by the company over and above the face value of its shares when they were originally issued. The excess amount (premium) can be used to issue bonus shares.

• Capital Reserves: When the company receives profits from revaluation of assets or a sale of some fixed assets, it gets specific capital profits. The company can leverage these reserves to issue bonus shares. 

• Capital Redemption Reserves: When a company buys back its own shares, reducing its total share capital, it creates a capital redemption reserve. This reserve can then be used to issue bonus shares, ensuring the company's share capital remains unchanged from its original level.
  

2. Partly Paid Bonus Shares

This type of bonus shares is only partly paid as compared to the fully paid bonus shares. Investors purchase these bonus shares by part payment initially. They can pay the rest later when the company asks for it. 

Impact of Bonus Shares

Did you know that by February 2024, there were more than 35 bonus issues in India?

The bonus share issuance impacts the companies as well as the shareholders. Let’s look at each of these impacts separately.

Impact on Companies

• Increased Liquidity

The issuance of bonus shares increases the circulation of shares in the market. This increases the stock’s overall liquidity, which makes it attractive for investors.

• Holdings

The bonus issuance lowers the share price of the corporation. However, this has no effect on the total shareholding.

• P&L

The P&L of the company will drop until the bonus shares are credited to the demat account. After the shares are credited, the P&L will be updated. This entire process may take up to 15 days.

Impact on Shareholders

• No Tax Liability

Bonus shares are tax-free. You don’t have to pay any tax to get the benefit of bonus shares.

• Capital Appreciation

In the long run with the growth in the company, its bonus share will also appreciate. Hence, shareholders will gain higher returns.

Must Read: What Are The Major Things You Need To Know About Bonus Shares?

Important Dates and Eligibility

Below are certain dates and eligibility criteria which are important in the aspect of bonus shares:

Record Date

For the upcoming bonus shares issue, the shareholder needs to have shares in their holding on the record date. It is similar to a cut-off date, which makes shareholders eligible for bonus shares.

Eligibility of Bonus Shares

A person who wants to be eligible for the bonus issue of the company needs to hold the shares on the record date (the cut-off date set by the company to check the eligibility of the shareholders).

Advantages and Disadvantages

Bonus shares have advantages as well as disadvantages for both the company and its shareholders. Let’s dive deeper into this below:

For Investors

Advantages

• The investors don’t have to pay any taxation on bonus shares received.

• Bonus shares develop trust in the minds of investors. It makes them believe that the company is growing in its business.

• It is a very good investment option for the long term.

• It allows investors to increase their holdings without spending money.
  

Disadvantages

• Bonus shares result in reduced EPS, which negatively impacts the valuation perceived by investors.

For Companies

Advantages

• The company can increase its shareholding and its overall market value with the help of bonus shares.

• Bonus shares are the result of a good financial year for the company.
  

Disadvantages

• The company is not able to raise money by issuance of bonus shares.

Issuing Bonus Shares

There are certain conditions for the issuance of bonus shares, as mentioned below:

Conditions for Issuance

• The company’s Article of Association (AOA) needs to have the provision of bonus shares.

• The management of the company has to pass the resolution of the bonus share issuance in the company’s annual general meeting. It needs to be recommended by the board of directors and approved by shareholders.

• The company needs to inform the stock exchange about the bonus issue.

• If the company has outstanding loans, then they need to get permission from the lenders before issuance of bonus shares.

Bonus Shares Vs Stock Splits

• Bonus shares give additional shares to the existing shareholders. Whereas in a stock split, the company’s existing stocks are divided into multiple shares.

• Bonus shares improve liquidity, whereas a stock split reduces the share price and makes it affordable.