What Is Bonus Issue And What Is Its Purposes/Reasons (Part 1 of 2)

An alternative strategy when you have a small capital base,future prospects seems bright and the environment is good it’s time to go for bonus issue.

Bonus issue can be quite prevalent hence can be one of the popular company alternative to attract investors to participate in the listed company’s shares,this article seeks to look into the basic details of bonus issue:

• What is bonus issue
• Purpose or reason for bonus issue
• Difference between a dividend payout and bonus issue
• Ex and cum date of bonus issue
• Is there an advantages/disadvantage for the existing shareholder of a company which issues bonus issue?
• Simple illustration of bonus issue ( refer next article)
• Accounting treatment of bonus issue ( refer next article)

Let’s look at the following details of bonus issue:

What is Bonus Issue?

• A bonus issue is the issue of new ordinary shares at no cost to existing shareholders,but out of the company’s reserves and in direct proportion to their existing shareholdings in the company.

• Bonus issues are used to enlarge the capital base of the company and also as a means of rewarding existing shareholders.

• A bonus issue is normally done via retained earnings. Bonus issue is just a book entry shifting from retained profit to share capital. This is also known as capitalization of reserves.

• Rewarding shareholders via a share split such as issuing bonus shares did not have any effects from the balance-sheet perspective.

• The issuance of bonus shares is governed by specific rules and regulations and importantly,a company must have adequate reserves on the balance sheet.

So after understanding what is a bonus issue,what do you think will be the purpose or reason for embarking such strategy:

Why bonus issue?

• To conserve cash by declaring a bonus issue in lieu of a cash dividend ( or an increased dividend )

• To reduce misunderstanding caused by expressing dividend ( out of profits earned on total capital employed) as a percentage of the nominal value of the issued share capital. As we are aware that dividend payout is based on the nominal value of the issued share capital and NOT on shareholder funds. So the dividend payout might seems to be unduly high which might lead investors to think that the company is over generous by forsaking the relevant investment in capital expenditure or increasing the working capital.

• Again,another reason is also to align the earning per share. Due to the smaller number of share capital,the earnings per share would also not been properly align to other similar companies which would have already take on a bonus issue re:capitalization of reserves.

• To make use of a company’s share premium account. As bonus issue can be created vide capitalization from the share premium account,this might be one reason that a company might want to have a bonus issue.

• As issuing bonus shares has the effect of diluting earnings per share and lowering a company’s share price,the share would then become more affordable which would then encourage potential investors to invest in the stock.

• As the bonus issue would have increase the number of shares in the market,It therefore increases the liquidity/marketability of the stock

• As a double edge sword namely the issuance of bonus shares could be deemed a “reward” to shareholders as well as a way for a company to issue more shares at a lower price to attract potential investors.

• Applies often for stocks that are generally cheaper and smaller in market capitalisation. To grow faster,these small companies may want to expand their capital base. The bonus issue will reduce the price of a stock initially,but this could attract punters and investors to buy the counter in the hope that there could be a potential upswing in the stock in the longer term.

• If a company came up with further new share issues by way of private placement,the earlier bonus issue will only be mere capital split and would still allow a higher percentage stake given to new investors that could be an attractive feature.

• The bonus issue coupled with the necessary right issues are used to complement the ascendancy from a Second board to the Main board status. This is to comply with the minimum paid-up capital requirement of RM60mil for a company seeking to transfer its listing to the Kuala Lumpur Stock Exchange (KLSE) main board.

• Lastly,it helps to reinforce the fact that those reserves which have been invested into long term assets cannot be used anymore for dividend distribution. This is particularly true,if we see a small capital base,very substantial fixed assets investments and higher than normal earning per share and dividend payout.

Difference between a dividend payout and a bonus issue

• Both (dividend and bonus issue) could be a way for companies to reward shareholders,but

• A dividend payout could imply that the company had excess funds or no current business expansion plans,and had decided to return some of its capital reserves back to shareholders.

• A dividend payout involved actual funds being apportioned to shareholders based on the number of shares held.

Mechanic of Ex &Cum-date of bonus issue entitlements

• To be entitled to the bonus issue,we need to take note of the ex-date as only shares bought before the ex-date will be entitled to the shares.
• The cum-period refers to the period from announcement day of the entitlement of bonus or rights issue or dividend to the day before the ex-date. Normally,cum is a prefix meaning “with.”
• A share that is cum-dividend means the buyer is entitled to a dividend currently attached to it. The same is true for cum-rights and cum-bonus.

Any effect to the existing shareholders?

• If the capital were expanded by bonus shares,then the existing shareholders would already have a higher stake vis-à-vis further new issue size.
• In a bullish market,market punters might construe the bonus issue for better things ahead for the company and the share price might shoot up though theoretically it should not

• Rights Issue:Understanding Its Purpose,Mechanism &Difference Between Bonus Issue
• Cautious with Bonus Issue
• Bonus Issue – Illustration And Accounting Treatment ( Part 2 of 2)
• How To Spot Companies Which Are Likely To Issue Bonus Issue
• How To Check For Companies Who Might Propose Bonus Issue
• Bonia Proposes Main Board Transfer,1-for-2 bonus,Share Split
• AMolek ABORTS Proposed Rights,Bonus Issue