Bonus shares are extra shares that are issued to current owners at no additional cost based on how many shares they currently possess. These are the company's accumulated earnings that are converted into free shares rather than being distributed as dividends.
This blog is dedicated to defining bonus shares, what a bonus issue of shares is, and what is a bonus in the share market.
What are Bonus Shares?
The bonus shares meaning states that they are the additional set of shares allotted by the company to the existing shareholders as a 'bonus.' These additional shares are allotted because the company can't pay dividends to shareholders despite making profits. However, bonus shares can only apply when the company has a massive free reserve and has booked hefty profits.
Furthermore, these reserves or profits cannot be used for other purposes than to distribute dividends. The bonus shares are distributed according to the shareholder's proportionate share in the company.
For example, if a company announces a one-for-one bonus share, the shareholder will hold double its current holding. Let's assume shareholder A had 200 shares in company XYZ. After announcing one on one bonus shares, shareholder A will hold 400 shares in company XYZ.
Who is eligible for bonus shares?
The shareholders who hold the company's shares before the record date and ex-date qualify to receive the bonus share. In India, companies follow a system wherein the record date falls two days after the ex-date. To earn bonus shares, shareholders must hold shares before the ex-date. If someone bought shares on the ex-date, they wouldn't qualify for earning bonus shares.
The bonus shares are allotted after they get their new ISIN. The process usually takes 15 days.
Advantages of Bonus Shares
Bonus shares benefit both the company and shareholders. Here's how:
● Bonus shares help the company sail out of the situation of sharing cash dividends with the shareholders.
● Shareholders gain trust in the company after receiving bonus shares.
● The company increases its shareholding and spikes market value with bonus shares.
● Bonus shares signify that a company has had a good financial year.
● Investors earning bonus shares fall out of taxation.
● It is a promising option for long-term holders.
● Investors have increased their holdings in the company without spending anything.
Disadvantages of Bonus Shares
There are some disadvantages to bonus shares too. Here are a few:
● Shares help in raising money. However, bonus shares raise no money and defy the concept of shares.
● If a company opts to issue bonus shares over dividends, it increases the burden on the company in the long run.
● Shareholders who invest to earn dividends might step back from further investment.
● There is not much of a disadvantage for an investor. However, if the investor was eyeing a dividend, bonus shares can be disappointing for them. In the long run, bonus shares could be a better deal.
Types of Bonus Shares
The companies can choose to announce bonus shares or not. They can pick from
● Fully paid bonus shares
The bonus shares come from the capital reserve, redemption reserve, profit and loss account, or security premium account. These shares are not circulated with an increased proportion. Instead, the shareholders get the exact number of shares they held before the ex-date.
● Partially paid bonus shares
The partially paid bonus shares apply to the partially paid shares. These are the shares the shareholders partially paid at issuance. The rest of the amount is due when the company makes the call.
When the company announces a partially paid bonus, the remaining amount of shares gets fulfilled. The partially paid shares become fully paid shares. These bonuses can be issued from the capital reserve. The company can't use the capital redemption reserve and security premium account to issue partially paid bonus shares.
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Frequently Asked Questions
The bonus shares are first issued under a non-permanent or temporary ISIN. Moving from temporary ISIN to permanent ISIN involves 4-5 business days. Once it is converted to a permanent ISIN number, the bonus shares are eligible for trading.
Bonus and stock splits are the sources of increasing liquidity in the company. The bonus shares increase shareholders' holdings in the company, while the stock split makes the stocks more affordable.
Shareholders who own company stock before the record date and ex-date are eligible to receive bonus shares.