RIGHT SHARES AND BONUS SHARES

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Rights Issue or Pre-emptive Rights - meaning

Subsequent issue of shares by an existing company to existing shareholders are known as rights issue.

Section 81 of the Companies Act, 1956 provides:Where at any time after the expiry of two years from the formation of a company or the expiry of one year from the first allotment of shares in the company, whichever is earlier, the Board of Directors, decide to increase the subscribed capital of the company by the allotment of further shares , then:

1. Such further shares shall be offered to the existing shareholders proportionately to their equity holdings on that date.

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2. The offer shall be made by a notice.3. Unless the Articles of Association of the

company otherwise specify, the offer shall be deemed to include a right exercisable by the person concerned to renounce the shares.

4. Incase the shareholders declines to accept the shares offered, the Board of Directors may proceed to dispose off such shares offered in such manner as they consider most beneficial to the company.

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Advantages of Rights Issue The control of the company is retained in

the hands of the existing shareholders. The existing shareholders do not suffer

on account of dilution in the value of their holdings if fresh shares are offered to them because value of shares is likely to fall with fresh issue.. This decrease in the value of the shares will be compensated by getting new shares at a price lower than the market price.

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• The expenses to be incurred, if shares are offered to the general public, are avoided.

• Image of the company is bettered as existing shareholders remain satisfied.

• There is more certainty of getting capital by rights issue than by when fresh issue of shares made to public.

• Directors cannot misuse the opportunity of issuing new shares to their friends and relatives.

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VALUE OF THE RIGHT

R = M-S N+1

R=Value of one right shareM=Cum- right market price of a shareS= Subscription price for a new shareN=Number of old shares required to

purchase one right share

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Valuation of Ex-right Share- The ex-right value of a share can be

calculated by deducting the value of right from the cum-right market price of the share

P = MN+S N+1

P=Market value of share ex-rightM=Cum –market priceS=Issue price of a new shareN=Number of existing shares required for

getting one right share

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BONUS SHARES OR CAPITALISATION OF PROFITS

Bonus paid to shareholders can be either cash or capital bonus.

A company gives bonus to its shareholders only when it has larger reserves and sufficient cash to pay bonus.

Capital bonus is paid when the company wants to share the accumulated reserves with shareholders but it is not in a position to pay cash bonus.

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Capital bonus or capitalisation of profits

Capitalisation of profits can be done in two ways:

(i) By making partly paid shares as fully paid.

(ii) By issuing fully paid bonus shares to existing shareholders free of cost.

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Circumstances for Issue of Bonus Shares

When a company has large accumulated reserves (whether capital or revenue).

When the company is not in a position to give cash bonus.

When the value of fixed assets far exceed the amount of the capital.

When the higher rate of dividend is not advisable because shareholders will demand the same rate in future which the directors may not be able to give.

When the market price of shares far exceeds the paid up value of shares.

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Free Reserves that can be Used for Issue of Bonus Shares

Surplus in Profit and Loss A/c. General Reserve. Dividend Equalisation Reserve. Capital Reserve arising from profit on

sale of fixed assets received in cash. Balance in Debenture Redemption

Reserve after redemption of debentures.

Capital Redemption Reserve A/c. Securities premium collected in cash

only.

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Reserves not available for Issue of Bonus Shares

Capital Reserve arising due to revaluation of assets.

Securities Premium arising on issue of shares on amalgamation or take over.

Investment Allowance Reserve/ Development Rebate Reserve before expiry of 4 years of creation.

Balance in Debenture Redemption Reserve account before redemption takes place.

Surplus arising from a change in the method of charging depreciation.

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Accounting Treatment

(A) If the bonus is utilised by making existing partly paid shares fully paid shares:

(i)

(Being amount transferred for bonus payable to shareholders)

(ii)

(Being final call due on shares)

Profit and Loss A/c Dr.General Reserve A/c Dr.Capital Profit A/c Dr.

To Bonus to Shareholders A/c

Share Final Call A/c Dr.To Share Capital A/c

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(iii)

(Being bonus to shareholders utilised to make the final call paid –up)

Bonus to shareholders A/c Dr.To Share Final Call A/c

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(ii)

(Being issue of bonus shares)

Bonus to Shareholders A/c Dr.To Share Capital A/c

To Securities Premium A/c

(B)If the payment of bonus is made by the issue of free fully paid bonus shares:

(i) Profit and Loss A/c Dr.General Reserve A/c Dr.Capital Redemption Reserve A/c Dr.Securities Premium A/c Dr.Capital Reserve A/c Dr.Other reserve A/c Dr.

To Bonus to Shareholders Account

(Being amount transferred for issue of bonus shares)

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Bonus Shares Right Shares

Bonus Shares are issued to the existing shareholders free of cost.

Existing shareholders have to pay for taking right shares.

No facility for renunciation is available.

Shareholders may renounce the right shares partly or totally.

Bonus Shares are always fully paid up.

Right Shares can be fully paid up or partly paid up.

Issue of Bonus Shares is according to the provisions of AOA and SEBI guidelines.

Issue of right shares is regulated by Section 81 of the Companies Act.

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bonus shares right shares

Issue of bonus shares do not increase cash because shares are issued free of cost.

Issue of right shares increases working capital

There is no requirement of minimum subscription

Issue of right shares is subject to minimum subscription

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• There is a sharp rise in the prices of equity shares following the declaration of bonus issue.

• After the issue of Bonus Shares , other things remaining the same, the price of shares will come down.

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