Define Bonus Issue

Bonus Issue

What is a Bonus Issue, and what does it entail?

A bonus issue, also known as a scrip issue or a capitalization issue, is when a company offers current shareholders free extra shares. As an alternative to boosting the dividend distribution, a firm may opt to distribute additional shares. For every five shares owned, a firm may provide one bonus share.

TAKEAWAYS IMPORTANT

• A bonus issuance of shares is stock issued in place of cash dividends by a firm. To address their liquidity demands, shareholders might sell their shares.

• Bonus shares boost a company's stock price but not its net worth.

Bonus Issues: An Overview

When corporations are short on cash and shareholders demand a regular income, bonus issues are issued to shareholders. The bonus shares can be sold by shareholders to suit their liquidity needs. Bonus shares may also be issued to help the corporation reorganise its reserves. There is no cash flow involved in issuing bonus shares. The company's share capital is increased, but not its net assets.

Bonus shares are distributed in proportion to each shareholder's ownership position in the business. Bonus issues do not erode shareholders' equity since they are distributed in a constant ratio to existing shareholders, preserving each shareholder's relative equity before the issue. A three-for-two bonus issue, for example, entitles each shareholder to three shares for every two shares held before the issuance. A 1,000-share shareholder receives 1,500 bonus shares (1000 x 3 / 2 = 1500).

Bonus shares are not taxable in and of themselves. However, if the stockholder sells it for a profit, they may have to pay capital gains tax.

A bonus issue is essentially a reclassification of reserves for internal accounting purposes, with no net change in overall equity, albeit its composition is altered. A bonus issue is a company's share capital increase combined with a reduction in other reserves.

The Benefits and Drawbacks of Issuing Bonus Shares

In order to provide income to shareholders, companies with little resources may issue bonus shares rather than cash dividends. Because issuing bonus shares raises the firm's issued share capital, the company seems to be larger than it is, making it more appealing to investors. Furthermore, increasing the number of outstanding shares lowers the stock price, making it more accessible to individual investors.

However, issuing bonus shares depletes the cash reserve more than paying dividends. Furthermore, because issuing bonus shares does not create income for the firm, it may result in a future decrease in dividends per share, which shareholders may not like. Furthermore, selling bonus shares to address liquidity demands reduces shareholders' percentage ownership in the firm, giving them less control over how it is run.

Bonus Shares and Stock Splits

There are numerous parallels and distinctions between stock splits and bonus shares. When a firm declares a stock split, the number of shares issued rises, but the value of the investment stays the same. Companies usually proclaim a stock split to offer greater liquidity to their shares, increase the number of shares available for trading, and make shares more accessible to individual investors.

There is no gain or decrease in the company's cash reserves when a stock is divided. When a business distributes bonus shares, however, the shares are paid for with cash reserves, which depletes the reserves.