Bonus shares

[Nauman]

Can anyone please explain to me in detail about
a) when are bonus shares issued?
b) what implications does issue of bonus shares have on the company?
c) its treatment

Thanks

Regards

[kamranACA]

Dear Nauman,

The issuance of Bonus shares depends upon management's (Board of directors own decision who recommend it for approval in general meeting of shareholders/members. Bonus shares are basically the capitalisation of reserves into share capital. The bonus shares issuance does not bring any cash or cash equivalent resource to the company. Its issuance does not also alter the position of equity before and after its issuance.

You can study the Rule 6 of Companies (Issue of Capital) Rules 1996. These rules can be located in any bound of Companies Ordinance, 1984 available in market.

As far as treatment is concerned, it has already been discussed under this sub-forum in another thread. You must read it in detail.

Best regards,

Kamran.

[bilal azhar]

Bonus shares are issued by capitalising the profit.one thing i would like to ask is that "whether a company who is in losses ever since its incorporation,can issue bonus shares by capitalising its losses that is
Losses Dr.
Bonus Shares Cr.

If not why.

[kamranACA]

Dear Mr. Bilal Azhar,

Please revisit your query. Your query is wrong in its fundamentals.

Loss carries Debit balance while Profits/Reserves carry Credit balance in the Trial Balance or Balance Sheet.

Check this fundamental and then re-consider your query.

A Credit balance can be transmitted into another credit balance by eliminating or reducing (debiting) its ownself. Likewise, a Debit balance can be transmitted into another debit balance by reducing or eliminating (crediting) its ownslef.

Examples are

When bonus shares are issues the credit balance of reserves or profits is transmitted into another credit balance i.e. Share Capital through following journal entry

..........Reserve (Debit)

.................Ordinary Share Capital (CREDIT)

Likewise, cash is an asset of debit balance and can be converted into another asset say furniture (debit balance) by reducing or crediting its ownself

............Furniture account (Debit)

......................Cash account (Credit)


Now if you see that if LOSSES have the debit balance, these cannot be transmitted into a credit balance. If we pass following journal entry

................Losses (DEBIT)

........................Ordinary share capital (CREDIT)

then it will enhance the losses instead of transmitting or reducing itself. This would be a non-sense to pass such a journal entry and will make no legal basis.

When a balance does not exist, it cannot be transmitted.

Hope you will understand this clarification.

Regards,

Kamran.

[bilal azhar]

ok thanks kamran sb.
if a company has a current year profit and last years accumulated losses(losses since its incorporation) can it declare bonus shares from this profit.

[kamranACA]

Dear Bilal Azhar,

I referred you people to see rule 6 of Companies (Issue of Capital) Rules 1996. There might have been some problem for you guys in locating these rules. I hereunder narrate its contents which will more appropriately clarify your query

QUOTE

Rule 6 says

A listed company can issue bonus shares subject to the following conditions, namely-

(i) the decision of directors to issue bonus shares shall be communicated to the authority (SECP) and the respective stock exchange on the day of the decision and the intimation letter shall be accompanied by the auditors' certificate as specified in clause (iii) {below}.

(ii) the free reserves of the company calculated in the manner as specified in rule 5 (of above mentioned rules) shall be sufficient to issue bonus shares after retaining in the reserves 25% of the capital as it will be increased by the proposed bonus shares;

(iii) a certificate from the auditors shall be obtained to the effect that the free reserves and surpluses (i.e. accumulated profits) retained after the issue of bonus shares will not be less than 25% of the increased capital; and

(iv) all contingent liabilities disclosed in the audited accounts and any such liability which may have been created subsequent to the audited accounts shall be deducted while calculating minimum residual reserves of twenty five percent.

UNQUOTE

This shows that a listed company can only issue bonus shares if it is ensured that after issuing the bonus shares its FREE RESERVES will not be less than 25% of the total increased share capital amount after the proposed bonus issue. Free reserves have been defined in rule 5 as under

QUOTE

Free reserves include any amount which having been set aside out of revenue or other surpluses after adjustment of all intangible or fictitious assets, is free in that it is not retained to meet any diminution in value of assets, specific liability, contingency or commitment known to exist at the date of balance sheet, but does not include-

(i) reserve created as a result of revlauation of fixed assets;

(ii) good will reserve;

(iii) depreciation reserve to the extent of ordinary depreciation including allowances for extra shifts admissible under the provision of income tax ordinance; (i.e. accumulated depreciation appearing in accounts)

(iv) development allowance reserve created under the provisions of income tax ordinance;

(v) workers' welfare fund

(vi) provision for taxation to the extent of deferred or current liability of the company; and

(vii) capital redemption reserve.


UNQUOTE

To simplify the things you can understand that free reserves include the reserves which are not specifically created to meet any specific expenditure, loss or out flow of economic resources. Any reserve which would be general in its nature will be included in free reserves like share premium, general resreves, accumulated profits etc. However, law requires to deduct the value of intangible assets, contingent liabilities and comitments (disclosed in accounts) from the such reserves to calculate exact amount of free reserves.

Now coming to your query. If a company has accumulated losses and its current year's results are in profit, this would not be sufficient information to decide whether or not it can issue bonus shares. We will have to look on all of its free reserves before deciding its capability for issuing bonus shares. Some times due to certain appropriations, the accumulated profits are transferred to revenue reserves. In such case, if subsequently the company goes into losses, its accumulated profit can become negative and appear as accumulated loss but still it may has overall positive equity and positive frees resreves (in total) due to already appropriated and accumulated reserves under various headings even after adjusting for the negative balance of accumulated losses. In such cases, bonus shares can be issued by debiting other available free resreves and crediting bonus shares.

The matter is to judge the free reserves position and not merely the profitability. However, if in any case there is no other sufficient reserve and the profitability is also vanished and there appear accumulated losses, then of course the company can not issue bonus shares.


Hope you have recieved the required clarification.

Best regards,

KAMRAN.

[rambo]

Sir Mr KAMRAN SAHIB kia Bonus shares ka istamal profit ko taqseem karne kee liyee bhi kia jata hai, Here in Lahore one of our teacher says that companies do use bonus and right shares to distribute heavy amounts of their profits in the their forengh investors.

[kamranACA]

Dear,

All profits ultimately make part of "Revenue Reserves" which are normally free reserves unless these are not retained for any specific declared purpose. "Accumulated profit" or "Un-appropriated Profit" had been a part of the definition of "reserves" provided by the 4th Schedule to the Companies Ordinance 1984. Reserves also include some capital reserves which do not arise from the profit and loss account and are directly credited in the equity. Examples are share premium account (received on issuance of share capital sat more than the face value), fair value reserve (created by recognising gains on financial assets treated as "available for sale" financial assets) etc. Capital reserve and revenue reserve are different terms while free reserve and non-free reserves are different terms. A capital reserve can also be a free reserve e.g. share premium.

As far as bonus shares are concerned, basically these are issued for two reasons. Firstly, to enhance the share capital by capitalising the free reserves/accumulated profits without calling for a right issue. Secondly, to transfer some benefit from the reserves/profits to the shareholders for holding such shares as investment. Bonus shares are, therefore, aslo called as STOCK DIVIDEND i.e. dividend in shape of "common stock" i.e. ordinary shares.

As per above clarification, it is true that bonus shares can be issued for distributing profits among shareholders in the shape of common stock without the distibution of cash resources of the company.

Now coming to the Right Issue. Right issue, truly speaking, infact always carry a characteristic or element of bonus issue to some extent which is normally embedded in the fundamentals of such issue. However, right issue benefits the existing shareholders in the manner of foregoing some cash resource or addition to equity by the company, for the sake of the shareholders, that is expected to be received by the company. For example, is market value of share of a company is Rs 30 and the right is being given to existing shareholders at Rs 2 premium with face value of Rs 10, then it means company will recieve only Rs 12 against the issue of the right share whereas the market price of the share was Rs 30. This shows that there is an embedded bonus element (in value) of Rs.17 per share on each of the right share issued. However, this is not an outflow of economic resources from the company and do not either represent the profits pay out or cash pay out straightforwardly. This is just the lesser reciept of share premium than what could be expected. Again it is expectation, as dilution of EPS on share issue will also affect the share's market price and PE ratio after its issuance unless resources are so efficiently utilized that proft earnings match the increase in shares. This is a lengthy discussion. I can only say that Right share issuance does not straightforwardly result in pay out of profits of the company.

However, bonus share issuance is the pau out to shareholders of accumulated profits or reserves.

Hope ur query has been resolved.

Best regards,

Kamran.

[Muhammad Amir]

A bonus issue is Actually done via retained earnings bonus issue is just a shifting of retained profits to share capital this is known as capitalization of reserves.
<b>
ENTRY-

DRRetained Earnings XXXX
CR Share Capital XXXX
</b>
SEE EXAMPLE-

If a Company has
<b>
Ordinary Share Capital of £10M and number of Shares also 10M
Capital Reserves of £20M
General Reserves of £10M</b>

Total Shareholders' fund is £40M

Now if a company issues one for one bonus issue then after the bonus issue impact on the shareholders funds are as follows
<b>
Ordinary share capital (20m no of shares) £10m +£10m =£20m
Capital Reserve £20m-£10m ===> £10m(See Below Entry)
General Reserve==============> £10m</b>

Still After Bonus Issue Shareholder's Total Fund if £40M...

ENTRY-
<b>
DRCapital Reserves £10M
CR Share Capital £10M</b>

In the end there is no change in Shareholder's Equity because One Account named as Share Capital with the nature Capital Increases and at the same time Other Account named as Capital Reserves with the nature Capital Decreases....

[kamranACA]

Dear Shoaib,

I wonder if it was supposed to be a question from you. It's strange. You must have some other reason to ask it. Come to the point directly ) .

Regards,


Kamran.