Study Notes
Bonus Issue and Rights
Issue
Rights Issue and Bonus Issue
Rights Issue
Covered in Section 62 of the Companies Act 2013
Relates to further issue of share capital to EXISTING SHAREHOLDERS
These are the shares which are offered to the existing members and the right of the
members to get these shares is called as Right of Pre-emption
Definition: Rights Issue is:
o An invitation
o To existing shareholders
o To purchase additional new shares in the company
o At a discount to the market price
o On a stated future date
Existing Shareholders
Procedure of Rights Issue – a company gives shares only to existing shareholders in a
certain ratio to the number of shares they already own. Example – one right share for
every 5 shares owned.
In a rights issue, a cut-off date is fixed known as “Record Date”
Rights shares are given only to those shareholders who own the company‟s shares on
the record date.
Those who buys the shares of the company after the record date, will not be entitled to
right shares despite the fact that the right shares will be issued after that date.
Rights issue is different from public issue of shares as follows:
Public Issue Rights Issue
Applications for the shares are invited from Shares are offered to the existing
general public shareholders or members of the company
The shares may be over/under-subscribed Can never be the case of over-subscription
leading to pro-rata allotment.
Cost of issue is comparatively higher Cost of issue id comparatively lower
The price of the public issue is generally The price of the rights issue is generally
higher than the rights issue and is kept in lower than the market price to be an
congruence to the market price attractive option to the existing shareholders
The communication of the issue is made The communication is between the company
through „prospectus‟ or advertisements in and the existing members of the company
the newspapers. through a „Letter of Offer‟
It may lead to dilution of shareholding for It does not lead to dilution of shareholding for
existing shareholders existing shareholders if all apply for rights
shares
2
Rights Issue and Bonus Issue
Impact of Rights Issue on Shareholders’ funds of company and shareholding
Let‟s say ABC Ltd wants to set up another plant to increase its production capacity. So they
want to raise capital for the new plant from its existing shareholders i.e. they come out with a
rights issue.
They require capital of Rs.100 crore and decide to issue the right shares to the existing
shareholders at Rs.100 per share when the market price of their shares is Rs.150 per share. As
such, they need to issue 1 crore new shares. The existing share capital of ABC Ltd is Rs.50
crore with face value (FV) of Rs.10 per share. Every right issue share will be issued for 5
existing shares. The shareholding pattern before rights issue is as follows:
Share capital Amount (No. of %
Shareholder No. of shares held
shares * FV) shareholding
1 1,00,00,000 Rs.10 crore 20.0%
2 75,00,000 Rs.7.5 crore 15.0%
3 65,00,000 Rs.6.5 crore 13.0%
4 60,00,000 Rs.6 crore 12.0%
5 50,00,000 Rs.5 crore 10.0%
6 40,00,000 Rs.4 crore 8.0%
7 35,00,000 Rs.3.5 crore 7.0%
8 30,00,000 Rs.3 crore 6.0%
9 25,00,000 Rs.2.5 crore 5.0%
10 20,00,000 Rs.2 crore 4.0%
Total 5,00,00,000 Rs.50 crore 100.0%
The company‟s shareholder funds also consist of following:
Share Premium = Rs.100 crore
No change in %
General Reserve = Rs.20 crore shareholding
Profit & Loss Surplus = Rs.30 crore after rights
After Rights issue
Existing number of shares = Shares capital/FV = Rs.50 crore/Rs.10 = 5 crore shares
Rights shares issued = 1 for every 5 existing = 1 crore shares
Rights share issue price = Rs.100 (this will consist of Rs.10 as FV and remaining Rs.90
as securities premium)
New shareholding pattern
Existing No. Rights shares New No. shares after New % shareholding
Shareholder
of shares (A) issued (B= A/5) rights (C= A+B) (C/Total shares after rights
1 1,00,00,000 20,00,000 1,20,00,000 20.0%
2 75,00,000 15,00,000 90,00,000 15.0%
3 65,00,000 13,00,000 78,00,000 13.0%
4 60,00,000 12,00,000 72,00,000 12.0%
5 50,00,000 10,00,000 60,00,000 10.0%
6 40,00,000 8,00,000 48,00,000 8.0%
7 35,00,000 7,00,000 42,00,000 7.0%
8 30,00,000 6,00,000 36,00,000 6.0%
9 25,00,000 5,00,000 30,00,000 5.0%
10 20,00,000 4,00,000 24,00,000 4.0%
Total 5,00,00,000 1,00,00,000 6,00,00,000 100.0%
3
Rights Issue and Bonus Issue
Shareholder‟s funds
Before Rights Rights Issue After Rights Issue
issue (A) (B) (A+B)
1 crore * Rs.10 =
Share capital Rs.50 crore Rs.60 crore
Rs.10 crore
1 crore*Rs.90 =
Share Premium Rs.100 crore Rs.190 crore
Rs.90 crore
General Reserve Rs.20 crore - Rs.20 crore
Profit & Loss Surplus Rs.30 crore - Rs.30 crore
Total Shareholders’
Rs.200 crore Rs.100 crore Rs.300 crore
Funds
Note: the existing shareholders may not always choose to buy the rights shares. They may
choose any of the following:
Existing shareholders action Impact on Equity capital Impact on shareholding
pattern
Buy the rights shares increases No change
Ignore rights issue No change No change
buy the shares and then sell them No change initially after rights
increases
off issue but changes after sell off
sell the right to someone else who
increases changes
buy the shares
Meaning and calculation of ex-Rights price
The ex-rights price is the estimated price of a share of a company following a rights issue.
It is usually estimated as the weighted average price per share of existing and the new
shares.
Ex-rights
(New Shares × Issue Price) + (Old Shares × Market Price)
Price = New Shares + Old Shares
In the above example, Shareholder 1 had 20 lakh shares and the market price at that time
was Rs.150 per share. He got 4 lakh new shares under rights issue at Rs.100 each.
Now after the rights issue, the average market price per share would be
= (4 lakh * Rs.100) + ( 20 lakh * Rs.150) / (20 lakh+ 4 lakh)
= (Rs.4 crore + Rs.30 crore) / 24 lakh = Rs.141.67 per share
As such, Rs.141.67 is the ex-rights price and the market price should fall from Rs.150 to
adjust for the rights issue.
It is important to know the ex-rights price as it tells what the shareholders actually get
instead of what the company promised. In the above example, the company offered 33%
discount on the on the market price (Rs.100 per share instead of market price of Rs.150),
but actually, the shareholder has got only 5.5% discount overall (Rs.141.67 cost on
market price of Rs.150).
4
Rights Issue and Bonus Issue
Calculation of the Value of Right
Since the rights issue is an incentive to the existing shareholders to get the share of the
company at a price less than the market price, there is a good demand of shares. The
quotation for existing shares tend to go up whenever there is a rights issue.
Calculation of “money value of right” is referred to as “Value of Right”.
Procedure for Calculation of Value of Right:
o Ascertain the market value of the share held by a shareholder
o Find out the rate or basis of rights issue. For example, if the company makes rights
issue of one share for every 5 shares held, then a shareholder must hold 5 shares
to claim one share under rights issue.
o If a shareholder owns 4 shares, he must buy 1 more from the market to claim one
share under the rights issue
o Let‟s assume that a market value of one fully paid-up share is Rs.150, then the
market value of the 5 shares will be Rs.750 (150*5)
o If one right is offered at Rs.125 for every 5 shares, then:
Value of right = Market Price – Average price of a share including the right share
(( ) ( )
i.e. 150 – = 150 - 145.83 = 4.17
( )
Therefore Value of Right =
( ) ( )
Market Value of a Share –
% increase in share capital after right issue =
% increase in total funds =
Bonus Issue
When a company has huge accumulated reserves, which cannot be distributed as dividends
in cash either because of legal restrictions or accounting principle of conservatism,
o it converts this surplus into capital (by process of capitalizing the surplus) and
o divides the capital among the existing shareholders in proportion to the share
capital held by them
o by issuing Bonus Shares
The company receives no cash by issuing bonus shares because here the company‟s
profits are capitalized. So, the shareholders to whom these shares are allotted, have to pay
nothing, i.e., Bonus Issue is made to the existing members free of charge
5
Rights Issue and Bonus Issue
Characteristics of Bonus Shares:
o Bonus Shares are issued to existing members
o These are always fully paid
o Right to renunciation or to reject is not available with respect to Bonus Shares
Section 63(1) of the Companies Act 2013 say that the bonus shares will be issued to its
members, out of the following:
o Free Reserves – The profits and the retained profits
o Securities Premium Account – the amount accumulated by selling the shares at a
premium
o The Capital Redemption Reserve Account – the amount of funds to be kept in a
separate reserve to maintain the capital base
Conditions for Bonus Issue as per Section 63
o Authorization by Articles of Association
o On recommendation of the board, been authorized in the general meeting of the
company
o Company has not defaulted in payment of interest or principle of any of its fixed
obligations
o The company has not defaulted in payment of statutory dues to its employees like
salary, gratuity, etc.
o The partly paid up shares on the date of allotment must be first converted into fully
paid-up shares
o Compliance with other conditions as may be prescribed
The bonus shares shall not be issued in lieu of dividends
Once a company announces the decision of the board recommending bonus issue, the
same cannot be withdrawn subsequently
Objectives of Bonus Issue
o Simple method to expand the capital base of the company
o Issue of bonus shares helps the company to retain its cash which could otherwise
been used up to pay dividends
o The bonus issue adds to the goodwill or reputation of the company
6
Rights Issue and Bonus Issue
Advantages of Bonus Issue
o From Company’s perspective:
Issue of bonus shares helps the company to retain its cash which could
otherwise been used up to pay dividends
Liquidity position of the company is not affected
Capital structure of the company becomes more realistic
The company is in a position to offer more security to its creditors
The company can reduce high rate of dividend
o From the shareholder’s perspective
No. of shares in the hands of shareholders increases
Whenever the shareholders need cash, they can realize it by selling the
additional shares that they have got
Impact of Bonus Issue on Shareholders’ funds of company
From an accounting perspective, a bonus issue is a simple reclassification of reserves
which causes an increase in the share capital of the company on the one hand and an
equal decrease in other reserves.
The total shareholders’ funds of the company therefore remain the same although
its composition is changed.
For example, the following is the capital structure of a company:
Equity share capital (1,00,000 of Face value of Rs.10 each) ……...Rs.10,00,000
Share Premium Account ……………………………………………… Rs.50,00,000
Retained Profits ……………………………………………………….. Rs.15,00,000
Revaluation Reserve …………………………………………………….Rs.5,00,000
The company decides to issue 1:5 bonus share (i.e. 1 bonus share for every 5 equity
shares held)
Now, Shareholders‟ funds (or net-worth) = Equity Capital + Reserves & Surplus
1. Before bonus issue
Shareholders‟ funds = Rs.10,00,000+50,00,000+15,00,000+5,00,000
= Rs.80,00,000
2. After Bonus share issue
Number of bonus shares to be issued = 1,00,000/5 = 20,000 shares
Value of bonus shares = 20,000*10 = Rs.2,00,000
Amount to be reduced from reserves (say, share premium account is used) = Rs.200,000
New share capital = Rs.10,00,000+Rs.2,00,000 = Rs.12,00,000
New Share Premium account = Rs.50,00,000 - Rs.2,00,000 = Rs.48,00,000
New Shareholders‟ funds = Rs.12,00,000+48,00,000+15,00,000+5,00,000
= Rs.80,00,000
Note – Revaluation reserve cannot be used for issue of bonus shares.
7
Rights Issue and Bonus Issue
Difference between Rights issue and Bonus Issue
Right Shares Bonus Shares
Issued for a price Issued free of cost
Can be partly or fully paid Are fully paid
May be renounced by a member in favor of Such facility is not available
his nominee
Made for raising funds in the company Made to capitalize undistributed profits
Governed by Section 62 of the Companies Governed by Section 63 of the Companies Act
Act 2013 2013
increases the shareholders‟ funds (i.e. net- No change in the Shareholders‟ funds as issue
worth) of the company as new capital is of bonus shares transfer the funds from reserves
raised to Equity Capital, both of which are part of the
shareholders‟ funds.
Share Split/ Stock Split
Share split transactions involves the division of issued shares of a company into a greater
number of shares without any further consideration from the shareholders.
This is done by reducing the face value of the share, while increasing the number of
shares such that the total share equity in rupee terms remains the same.
For example, say a company announces a 2 for 1 share split of its shares having face
value of Rs.10 each and the total number of shares of the company were 1 crore shares.
After the split, the following will be the situation:
Before Split After Split
Face Value per share (A) Rs.10 Rs.5 (10/2)
No. of shares (B) 1 crore 2 crore (1 crore * 2)
Total share capital (C=A*B) Rs.10 crore Rs.10 crore
As such, the total capital remains the same after the split but this capital is now
represented by a different number of shares.
Share split arrangements are usually undertaken by companies to improve the
marketability and liquidity of shares in the stock market. It also makes share affordable for
various investors who could not buy the shares of that company before due to high prices.