Guidelines and Procedures for Issuing Bonus Shares

Every year, when Indian companies post strong profits, quite a few of them reward shareholders not with cash, but with more shares. This is called a bonus issue, and it is one of the most common ways a company redistributes accumulated wealth without touching its cash reserves. For a B.Com student studying corporate accounting, bonus shares are also a neat bridge between company law, accounting entries, and market behaviour, all in one topic. Let us break down what bonus shares are, where the money for them legally comes from, and the rules a company must follow before it can issue even one.

What a bonus share issue actually means 🔗

A bonus issue is the conversion of a company’s accumulated profits or reserves into additional share capital. Existing shareholders receive new, fully paid-up shares in proportion to their current holding, and they pay nothing for them. If a shareholder holds 100 shares and the company announces a 1:2 bonus issue, they get 50 extra shares for free, taking their total to 150.

The word “bonus” is a little misleading. No new wealth is created. The company is simply moving an amount from its reserves to its share capital account and issuing shares against that amount. The shareholder’s proportionate ownership in the company does not change, only the number of shares representing that ownership does.

Why companies choose to capitalise profits this way 🔗

Companies sitting on large free reserves often prefer a bonus issue over a cash dividend for a few practical reasons.

• No cash outflow: The company retains its cash for operations or expansion while still rewarding shareholders.
• Better liquidity: A larger number of shares outstanding, at a proportionately lower price per share, can make the stock more affordable and improve trading volumes.
• Signal of financial strength: A bonus issue often indicates that a company has healthy reserves and confidence in its future earnings.
• Balances paid-up capital with reserves: Companies that have accumulated large reserves relative to their share capital use bonus issues to bring the capital structure back in proportion.

Where the money for bonus shares can legally come from 🔗

A company cannot capitalise just any account on its balance sheet. The Companies Act, 2013 permits fully paid-up bonus shares to be issued only out of specific sources.

Free reserves built from genuine profits 🔗

These are reserves created out of real, distributable profits, not out of accounting adjustments. SEBI is explicit that the bonus issue shall be made out of free reserves built from genuine profits or share premium collected in cash only, and that reserves created by revaluing fixed assets can never be capitalised for this purpose.

Securities premium account, but only the cash portion 🔗

If a company has collected securities premium in cash, that amount can be used for a bonus issue. Premium that arose from a non-cash transaction, such as a share swap during a merger, does not qualify.

Capital redemption reserve account 🔗

This is where the topic connects to another corner of corporate accounting. When a company redeems preference shares out of profits rather than out of a fresh issue of shares, it must transfer an equivalent amount to a Capital Redemption Reserve. That reserve, once created, can later be used to issue fully paid-up bonus shares, since it already represents capitalised profit rather than distributable cash.

What can never be used 🔗

Reserves arising from asset revaluation are permanently excluded. So is any reserve created without actual accrual of cash resources. The idea is straightforward: only reserves that represent real, realised profit can be turned into shares.

Conditions under the Companies Act, 2013 🔗

Section 63 of the Act lays down when and how a company may capitalise its profits or reserves for a bonus issue. A few conditions apply across all companies, listed or not.

• The Articles of Association must specifically authorise capitalisation of reserves. If the Articles are silent, the company must first pass a resolution to amend them.
• The issue needs a board recommendation followed by shareholder approval at a general meeting.
• The company must have no default in paying interest or principal on fixed deposits or debt securities it has issued.
• There should be no default in statutory dues owed to employees, such as provident fund, gratuity, or bonus payments, as the company must not be in arrears of any of these obligations before it can capitalise reserves.
• Any partly paid-up shares already in existence must be made fully paid-up before the bonus issue goes through.
• Bonus shares cannot be issued in lieu of dividend, and once the board has announced a bonus proposal, the company cannot subsequently withdraw the decision.

SEBI’s additional safeguards for listed companies 🔗

Listed companies face an extra layer of scrutiny under SEBI’s Issue of Capital and Disclosure Requirements framework, on top of the Companies Act. These rules exist to protect the interests of public shareholders and prevent the misuse of bonus issues as a market signal.

No bonus issue while FCDs or PCDs are pending conversion 🔗

If a company has outstanding fully convertible debentures (FCDs) or partly convertible debentures (PCDs), it cannot issue bonus shares to equity shareholders unless it extends a similar benefit to debenture holders. SEBI’s guideline requires the company to reserve shares in proportion to the convertible portion of such debentures, to be issued at conversion on the same terms as the original bonus.

Bonus shares cannot replace a dividend 🔗

A company cannot use a bonus issue as a substitute for paying cash dividends. The two serve different purposes: a dividend distributes actual cash, while a bonus issue merely restructures the balance sheet. Regulators keep this line firm so companies do not use bonus announcements to avoid a real cash payout to shareholders.

Reserves must be traceable to cash-backed profit 🔗

As with the Companies Act, SEBI reinforces that only free reserves built out of genuine profits or cash-collected share premium can be capitalised, and any reserve created without actual cash accrual is excluded even if it is technically labelled “free reserve” for other purposes.

A strict implementation timeline 🔗

Once a board approves a bonus proposal, the company cannot sit on it indefinitely. It must implement the proposal within six months of board approval and does not get the option to change its decision midway.

Articles of Association must permit capitalisation 🔗

This condition mirrors the Companies Act requirement. If the Articles do not already provide for capitalisation of reserves, the company must pass a resolution at a general meeting to insert such a provision before proceeding.

Step-by-step procedure for a bonus issue 🔗

What a bonus issue means for shareholders and the market 🔗

For an individual shareholder, a bonus issue does not add wealth on its own. The company’s total value stays the same; it is just spread across a larger number of shares. As a result, the share price typically adjusts downward in proportion to the bonus ratio, and per-share metrics like earnings per share get diluted in the short term, since the same profit is now divided among more shares.

What does change is accessibility and liquidity. A lower per-share price after a bonus issue can bring in more retail participation and improve trading volumes on the exchange. Shareholders also benefit if the company keeps growing, since a larger share count on a growing earnings base compounds their holding over time. The accounting impact is equally important for a B.Com student: the transaction moves an amount from reserves and surplus to the share capital account, without any change in total shareholders’ funds.

What do you think? 🔗

What do you think? If you were on the board of a company with strong free reserves but tight cash flow, would a bonus issue make more sense than a cash dividend? And how do you think retail investors should interpret a bonus announcement: as a genuine sign of financial strength, or mostly a cosmetic move that just increases the share count?

References

1. https://www.sebi.gov.in/guide/guide200015.html
2. https://www.onlinelegalindia.com/blogs/section-63-of-companies-act/
3. https://taxguru.in/company-law/bonus-issue-shares-section-63-companies-act-2013.html
4. https://www.sebi.gov.in/guide/guide200012.html