When an existing company offers further shares to its existing shareholders, it is called ‘Right Issue’. It is an issue of shares in which the existing shareholders have a legal right to subscribe for new shares. Usually a company offers right shares at a price much lower than the prevailing market price of the shares. If the company is prosperous and market price of its shares is more than the amount at which it has offered new shares, the right to buy more shares from the company will carry a price.

Are existing shareholders liable to necessarily accept the offer of Rlight Shares?

A company is under legal obligation to first offer the further issue of shares to its existing shareholders. But the existing shareholders are not liable to necessarily accept the offer so made. They have three options: Either (a) to apply for right shares; or (b) to reject the company’s offer; or (c) to renounce the right shares in favour of some other person for a price.

Legal Provisions regarding issue of Right Shares:

The legal provisions regarding issue of right shares are contained in Section 81 of the Companies Act, 1956. This Section provides that if a public limited company proposes to increase its subscribed capital at-^ny time after the expiry of 2 years from the date of its formation or at any time after the expiry of 1 year from the date of its first allotment of shares, whichever is earlier, by allotment of further shares, then the following provisions must be followed:

1. Such further issue of shares must be offered to the existing equity-shareholders of the company in proportion to the paid-up value of shares held by them.
2. The above offer must be made to the existing shareholders through a notice. The notice must specify the number of shares offered. A time limit of minimum 15 days from the date of such notice must be given to the existing shareholders.
3. Unless the Articles of the company otherwise provide, the notice shall contain a statement giving the right to the existing shareholders to renounce the shares offered to them in favour of any other person.
4. After the expiry of the time specified in the notice aforesaid or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept shares offered, the Board of Directors may dispose them of in such a manner as they are most beneficial to the company.

SEBI Guidelines:

1. Where the right issue is made at a premium, the company should disclose in the prospectus, the net asset value of the company, the low and high prices of shares for the last two years and a justification for the price of issue,
2. No bonus issue can be made within 12 months of any public or right issue.
3. Right issue should not be kept open for more than 60 days.
4. The quantum of right issues shall not exceed the amount specified in the prospectus/letter of offer. No retention of over - subscription is permissible.
5. The issue price is applicable uniformly to all shareholders. However, In the case of composite issues that combine a rights issue and public issue, the company can have different prices for the two issues.
6. The gap between the closure dates of various issues e.g., Right issue and Public issue, should not exceed 30 days.

The following steps may be applied for calculating the value of the right:

Step 1: Calculate the market value of shares which an existing shareholder is required to hold in order to get right shares.

For example, if a company makes a right issue of 1 share for every 2 shares held and the market price of one share at the time of announcement of right issue is Rs.240, then the total market price of 2 shares already held by a shareholder is Rs.480.

Step 2: Add to Step 1, the amount required to be paid to company for acquiring fresh shares. In the above example, an existing shareholder is entitled to get 1 new share for every 2 shares held. Now suppose that the company has decided to give one share of Rs.100 each at a premium of Rs.20 each. Thus the shareholder is required to pay Rs.120 for getting one right share. By adding Rs.120 to the amount as calculated in step 1, the total price of 3 shares is ascertained to be Rs.600 (i.e. 480 + 120).

Step 3: Ascertain the average price of one share by dividing the total price of all shares by the total number of shares. The average price is also called 'theoretical market price’.

In the above example, the average price of one share is Rs2.00 (i.e. Rs.600 / 4).

Step 4: Find out the difference between market price and the average price of a share. This difference is actually the value of right.

In the above example, the value of right will be calculated as follows:

Value of Right =         Market Price - Average Price (or Theoretical market price).

Value of Right =         Rs.240 – Rs.200 = Rs.40

Alternatively, the Value of Right can directly be calculated by applying the following formula:

Market Price per share - Right issue Price per share

Value of Right =  -----------------------------------------------------------

No. of shares to be held to get one right share + 1

‘Bonus Shares’     

The term ‘Bonus Shares’ refers to the shares issued by a company to its existing shareholders free of cost. A Company may decide to capitalize its profits by declaring bonus shares if it has large profits to declare dividend but does not posses sufficient cash to pay it

Legal Provisions for the Issue of Bonus Shares:

1. The bonus shares shall be issued out of free reserves built out of genuine profits or share premium    collected in cash only.
2. Reserves created by revaluation of fixed assets cannot be used for issue of bonus shares.
3. The declaration of bonus issue, in lieu of dividend, is not allowed.
4. The bonus issue cannot be made unless the partly - paid up shares, if any, are made fully paid-up.
5. Before declaring bonus shares, the company must ensure that if it has not defaulted: in payment of interest or principal in respect of fixed deposits or debentures; or
6. in payment of statutory dues of the employees such as contribution to provident fund, gratuity or    bonus.
7. There should be a provision in the Articles of Association of the company for the capitalization of   profits.
8. A company that announces its bonus issue after the approval of the Board of Directors must            implement the proposals within a period of 6 months from the date of such approval and shall not have            the option of changing the decision.
9. Consequent to the issue of bonus shares if the subscribed and paid - up capital exceed the authorized   share capital, a resolution shall be passed by the company at its general body meeting for increasing          the authorized capital.
10. No bonus issue shall be made which will dilute the value or rights of the holders of debentures,       convertible fully or partly. /

Meaning of Bonus Shares:

The term ‘Bonus Shares’ refers to the shares issued by a company to its existing shareholders free of cost. A Company may decide to capitalize its profits by declaring bonus shares if it has large profits to declare dividend but does not posses sufficient cash to pay it.

Bonus shares are generally issued in the following circumstances:

1. When the company is not in a position to give cash bonus.
2. When a company possesses large reserves and wants to capitalize these reserves by way of bonus shares.

SEBI Guidelines for the Issue of Bonus Shares:

1. The bonus shares shall be issued out of free reserves built out of genuine profits or share premium collected in cash only.
2. Reserves created by revaluation of fixed assets cannot be used for issue of bonus   shares.
3. The declaration of bonus issue, in lieu of dividend, is not allowed.
4. The bonus issue cannot be made unless the partly-paid up shares, if any, are made fully     paid-up.
5. Before declaring bonus shares, the company must ensure that if it has not defaulted:

1. in payment of interest or principal in respect of fixed deposits or debentures; or
2. in payment of statutory dues of the employees such as contribution to provident fund, gratuity or bonus.

1. There should be a provision in the Articles of Association of the company for the capitalization of profits,
2. A company that announces its bonus issue after the approval of the Board of Directors must implement the proposals within a period of 6 months from the date of such approval and shall not have the option of changing the decision.
3. Consequent to the issue of bonus shares if the subscribed and paid - up capital exceed the authorized share capital, a resolution shall be passed by the company at its general body meeting for increasing the authorized capital.
4. No bonus issue shall be made which will dilute the value or rights of the holders of debentures, convertible fully or partly.

Accounting Procedure for Issuing Bonus Shares:

Case A: If the reserves are to be utilised for issuing fully paid up bonus shares:

The journal entries will be as follows:

1. Entry for declaring bonus:

Surplus Account (Profit & Loss A/c)                 Dr.                                                       * * * *

General Reserve A/c                                       Dr.                                                       * * * *

Share Premium A/c                                          Dr.                                                       * * * *

Capital Redemptign reserve A/c                      Dr.                                                       * * * *

To Bonus to Shareholders A/c                                                                          * * * *

1. Entry for issuing bonus shares:

Bonus to Shareholders A/c                              Dr.                                                       * * * *

To Equity Share Capital                                                                                               * * * *

Case B: If the bonus is to be utilized for making partly paid shares fully paid-up:

The journal entries will be as follows:

1. Entry for making call:

Equity Share Final Call A/c                                           Dr.                                                       * * * *

To Equity Share Capitah A/c                                                                                                     * * * *

1. Entry for declaring bonus:

Surplus Account (Profit & Loss A/c)                              Dr.                                                       * * * *

General Reserve A/c                                          Dr.                                                       * * * *

To Bonus to Shareholders A/c                                                                                        * * * *

1. Entry for applying bonus towards the call amount:

Bonus to Shareholders A/c                                            Dr.                                                       * * * *

To Equity Share Final Call A/c                                                                                        * * * *