RIGHTS SHARES

When a company, having share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered to the existing share holders under Section [62(1) (a)]. It is called “Rights Issue”. If such shares are offered to employees, it is called “Employees Stock Option” under Section [62 (1) (b)].

Such shares can be offered other than existing share holders or employees, on preferential basis. Section 62 (1) reads “where at any time, a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered –

a) to persons who, at the date of offer, are holders of equity shares of the company in proportion, as nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer subject to following conditions namely –

 i) the offer shall be made by notice specifying the number of shares offered and limiting a time not being less than fifteen days and not exceeding thirty days from the date of offer within which the offer, if not accepted, shall be deemed to have been declined.

 ii) unless the articles of the company otherwise provide, the existing shareholder shall have a right to renounce the shares offered to him in favour any other person who need not be a member of the company.

iii) after the expiry of the time specified in the notice or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the share offered, “the Board of Directors may dispose off them in such a manner which is not disadvantageous to the shareholders and the company”.

Right issue-

Rights issue is an issue of rights to a company's existing share- holders that entitles them to buy additional shares directly from the company in proportion to their existing holdings, within a fixed time period. In a rights offering, the subscription price at which each share may be purchased is generally at a discount to the current market price. Rights are often transferable, allowing the holder to sell them in the open market.

The difference between the cum-right and ex-right value of the share is the value of the right.

The existing shareholders have right of first refusal, i.e., the existing shareholders enjoy a right to either sub-scribe for these shares or sell their rights or reject the offer.

Exceptions to the rights of existing equity shareholders

Section 62 recognises four situations under which the further shares are to be issued by a company, but they need not be offered to the existing shareholders.

The shares can be offered, without being offered to the existing shareholders, provided the company has passed a special resolution and shares are offered to

 

 

Employee Stock Option Plan

To employees under a scheme of employees’ stock option subject to certain specified

Conditions

Specified Conditions

To any persons, either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer subject to

certain specified conditions.

 

Payment in lieu of debentures or loans

Sometimes companies borrow money through debentures / loans and give their creditor an option to buy equity shares of a company. An option is a right, but not an obligation, to buy equity shares on a future date (expiry date) at a price agreed in advance (exercise price).

According to Section 62(3), nothing in this section shall apply to the increase of the subscribed capital of a company caused by the exercise of an option as a term attached to the debentures issued or loan raised by the company to convert such debentures or loans into shares in the company.

Provided that the terms of issue of such debentures or loan containing such an option have been approved before the issue of such debentures or the raising of loan by a special resolution passed by the company in general meeting.

 

As Directed by the government

It is a special situation where the loan has been obtained from the government, and government in public interest, directs the debentures / loan to be converted into equity shares.

According to Section 62(4), notwithstanding anything contained in sub-section (3), where any debentures have been issued, or loan has been obtained from any Government by a company, and if that Government considers it necessary in the public interest so to do, it may, by order, direct that such debentures or loans or any part thereof shall be converted into shares in the company on such terms and conditions as appear to the Government to be reasonable in the circumstances of the case even if terms of the issue of such debentures or the raising of such loans do not include a term for providing for an option for such conversion.

Provided that where the terms and conditions of such conversion are not acceptable to the company, it may, within sixty days from the date of communication of such order, appeal to the Tribunal which shall after hearing the company and the Government pass such order as it deems fit.

Note-

Companies Act does not allow issue of shares at a discount, except issue of sweat equity shares under Section 53.

Book Value of a share

Book value of a share = Net worth (book value)/ Number of shares

if there are 10,000 shares with book value 1,30,000. The book value of one share is (Rs 130,000/10,000 shares) Rs.13 per share. However, the market value may differ from the book value of shares. The market value of a company's shares represents the present value of future cash flows expected to be earned from the share in the form of dividends and capital gains  from  expected  future  share  price  appreciation.

 

Market Price-

Cum-right Market Price

The market price, which exists before the rights issue, is termed as Cum-right Market Price of the share. If the company decides to issue further shares, it may affect the market value of the share. 'Theoretically', the value of a company's shares after a rights issue must equal the sum of market capitalisation immediate prior to rights issue and the cash inflows generated from the rights issue.

Normally, the further public issue to the existing shareholders are offered at a discounted price from the market value, to evoke positive response as well as to reward the existing shareholders.

Assume 1,000 shares are issued (making it a right issue of 1:10; or 1 new share for 10 existing shares held) at a price of Rs. 14 per share. The existing worth of tangible assets held by the business shall become 264,000 (Existing net worth Rs 250,000 + Fresh Issue Rs. 14,000). Equity shares shall correspondingly command a valuation of Rs 2,64,000.

Ex- Right issue

The market price of the shares after further issue of shares (right issue) is termed as Ex- right Market Price of the shares. Theoretical Ex-Rights Price is a deemed value, which is attributed to a company's share immediately after a rights issue transaction occurs. This price is going to prevail after the further issue of shares is executed.

Example :

Mr.  Nayan has 100 shares of Prosperous Company before rights issue. Current worth of holding            = No. of shares X Cum-right Market Price

= 100 X25

= Rs 2,500

If Nayan exercises his right, he will pay Rs 14X10 shares = Rs 140.

His total  investment in the company including right is Rs 2,640 (Rs 2,500+Rs 140).

On a per share basis, it is Rs 2,640 /110 shares = Rs 24, which is the Ex-right Market

value of the share.

If Nayan does not exercises his right to further issue, his holding’s worth will decline to Rs 24 X 100 shares = Rs 2400. The law allows him to compensate for this dilution of shareholding by renouncing this right in favour of , say, Mr. Murli.

Nayan can charge Murli, in well functioning capital markets, this dilution of

Rs 100 by renouncing his right to acquire 10 shares. Hence Murli will be charged

Rs 10 per share (Rs 100 / 10 shares), in return for a confirmed allotment of 10 shares

at Rs 14 each.

For every share to be offered to Murli , Nayan must have ten shares at the back. Hence his holding of 10 shares fetches him right money of Rs 10 or Rs 1 per share held. This is exactly equal to the difference between Cum-right and Ex-right value of the share. It is termed as the Value of Right.

In a well-functioning capital market, this mechanism works in a fair manner to all the

participants.

Murli’s total investment will be Rs 140 (payable to Company) + Rs 100 (payable to Nayan, by way of value of right), or Rs 240. He will end up holding ten shares at an average cost of Rs 24, which is the Ex-right Market Price of the share.

Nayan will have a final holding of ten shares worth Rs 2400 + Rs 100 by way of value of right received from Murthy. It matches with his cum-right holding valuation.

In case the right issue offer is availed by an existing shareholder, the value of right is determined as given below:

Value of right = Cum-right value of share – Ex-right value of share

Ex-right value of the shares = [Cum-right value of the existing shares + (Rights shares X Issue Price)] / (Existing Number of shares + Number of right shares)

In our previous example, Ex-right value of share = [Rs250,000 + (Rs 14 X 1,000 shares)] / 10,000 + 1,000 shares = Rs 24

Value of right = Rs 25 – Rs 24 = Rs 1 per share.

The Ex-right value of the share is also known as the average price.

 

ACCOUNTING  FOR  RIGHT  ISSUE

The accounting treatment of rights share is the same as that of issue of ordinary shares and the following journal entry will be made:

Bank A/c Dr.

To Equity shares capital A/c

In case rights shares are being offered at a premium, the premium amount is credited to the securities premium account. The accounting entry is usual and is

Bank A/c            Dr.

To Equity Share Capital A/c

To Securities Premium A/c

 

 

Q. A company offers to its shareholders the right to buy 2 shares at Rs. 130 each for every 5 shares of Rs. 100 each held in the company. The market value of the shares is Rs. 200 each.

The value of right is-

a) 20

b) 30

c) 25

d) 22

a) 20

Value of right  = M+S/ N+1

                      =200-130       =              70__

                        2.5+1                        5/2+1

                     =70/3.5 = Rs.  20

The ratio is determined using a simple calculation:

 

N= Number of outstanding shares

       Number of New shares to be offered 

                           

R = Theoretical value of Right

M = Market price per share before rights issue (i.e., cum-right market price of a share)

S = Rights issue subscription price per share

N = Number of existing shares required to get a rights share

 

 

Bliss Ltd. announced a rights issue of four shares of Rs.100 each at a premium of 160% for every five shares held by the existing shareholders. The market value of the shares at the time of rights issue is Rs.395. What is the value of right?

Solution:

Value of right = R(M-S) = 4(395-260)   = Rs. 60

                          N+r           5+4

Where,

r = Number of rights issued = 4

N = Number of equity shares = 5

M = Market price = Rs.395

S = Issue price of rights = Rs.100 + (Rs.100 × 160%) = Rs.260

 

 

 

AIM Corporation is planning to raise funds by making rights issue of equity shares to finance its expansion. The existing share capital of the company is Rs.1 crore. The par value of its shares is Rs. 10 and the market price is Rs. 40. The right shares offered are 4 new shares for 5 old shares at par. The Theoretical market price after rights issue is

a) Rs. 25

b) Rs. 26.667

c) Rs. 32.567

d) None of the above

b) 26.667

     

Theoretical Ex-rights Price
=	New Shares × Issue Price + Old Shares × Market Price
	New Shares + Old Shares

 Theoretical market price after rights issue;        P =MN1 + SN2

                                                                                       N1+N2

   = 40X5+10X4   = 240/9 =Rs. 26.667

              5+4

 

AIM Corporation is planning to raise funds by making rights issue of equity shares to finance its expansion. The existing share capital of the company is Rs.1 crore. The par value of its shares is Rs. 10 and the market price is Rs. 40. The right shares offered are 4 new shares for 5 old shares at par. Value of rights is-

a) Rs. 13.33

b) Rs. 15.22

c) Rs. 14.21

d) None of the above

b) Rs. 13.33

 V = M-S     = 40-10    =  30         = 30 X4 = Rs. 13.33

      N+1        5/4 + 1     9/4             9

 

 

Bonus Shares

As per section 63, a company may issue fully paid-up shares to its members, in any manner whatsoever, out of :

 i) its free reserves;

 ii) the securities premium account;

iii) the capital redemption reserve account; provided that no issue of bonus shares shall be made by capitalising reserves created by the revaluation of assets.

 No company shall capitalise its profits or reserves for the purpose of issuing fully paid-up bonus shares unless–

a) it is authorised by its articles;

b) it has, on the recommendations of the Board, been authorised in the general meeting of the company;

c) it has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;

d) it has not been defaulted in respect of the repayment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus;

 e) the partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up. The Bonus Shares shall not be issued in lieu of Dividend. Bonus shares are not taxable in the hands of shareholders. Paid-up share capital increases with issue of bonus shares.

According to Rule 14 of Companies (share capital and debentures) Rules 2014, once the Board has recommended a bonus issue, it can not be withdrawn afterwards.

Bonus issue is also known as ‘capitalisation of profits’. Capitalisation of profits refers to the process of converting profits or reserves into paid up capital. A company may capitalise its profits or reserves which otherwise are available for distribution as dividends among the members by issuing fully paid bonus shares to the members.

A securities premium account and a capital redemption reserve account may be applied in the paying up of unissued shares to be issued to members of the company as fully paid bonus shares. In other words, securities premium account and capital redemption reserve cannot be applied towards payment of unpaid amount on any shares held by existing shareholders.

 

JOURNAL ENTRIES

1. Upon the sanction of an issue of bonus shares

 Capital Redemption Reserve Account a/c dr

 Securities Premium Account a/c dr

General Reserve Account dr

Profit & Loss Account dr

To Bonus to Shareholders Account.

2. Upon issue of bonus shares

Bonus to Shareholders Account Dr

To Share Capital Account.

3. Upon the sanction of bonus by converting partly paid shares into fully paid shares

General Reserve Account Dr

Profit & Loss Account Dr

    To Bonus to Shareholders Account

4. On making the final call due

Share Final Call Account Dr

To Share Capital Account.

5. On adjustment of final call

Bonus to Shareholders Account Dr

To Share Final Call Account

 

SEBI REGULATIONS-

Regulations 92- Conditions of Bonus issue

- it  is  authorised by its articles of association for issue of bonus shares, capitalisation of reserves, etc.:

 - it has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;

 - it has sufficient reason to believe that it has not defaulted in respect of the payment of statutory dues of the employees such as contribution to provident fund, gratuity and bonus;

- the partly paid shares, if any outstanding on the date of allotment, are made fully paid up

Regulation 93- Restriction on bonus issue

No issuer shall make a bonus issue of equity shares unless it has made reservation of equity shares of the same class in favour of the holders of outstanding compulsorily convertible debt instruments, if any, in proportion to the convertible part  thereof.

Regulation 94- Bonus shares only against reserves, etc. if capitalised in cash

All the profits that are realized in cash only then they can be used for bonus share issue

Regulation 95- Completion of bonus issue

-shall implement the bonus issue within fifteen days from the date of approval of the issue by its board of directors

-the bonus issue shall be implemented within two months from the date of the meeting of its board of directors wherein the decision to announce the bonus issue was taken subject to shareholders’ approval