Rights & Bonus Issues (Cambridge (CIE) AS Accounting): Revision Note

Rights issue of shares

What is a rights issue of shares?

• A rights issue involves existing shareholders being offered the option to purchase new shares based on the number they currently hold

  • E.g. a new share might be offered for every three shares the shareholders currently hold

• The issue is said to be fully subscribed if all shares are sold

What are the advantages of a rights issue of shares?

• A rights issue raises additional cash and permanent capital

  • The shares do not need to be repaid

• Control is not diluted

  • The shares are offered to existing shareholders

  • This is assuming the issue is fully subscribed

• Cheaper costs to issue the shares

  • The costs are cheaper to issue shares to existing shareholders than new shareholders

• The existing shareholders are already invested in the company's success

What are the disadvantages of a rights issue of shares?

• Existing shareholders might be unwilling to invest further

  • Particularly if the original shares were issued recently

How do I make the journal entries for a rights issue of shares?

• STEP 1
  Calculate the number of issued shares before the rights issue

  • share capital ÷ nominal value

• STEP 2
  Calculate the number of new shares issued

  • Use the ratio given in the question

    • e.g. if two shares are issued for every nine held then divide the current number of shares by nine and multiply by two

• STEP 3
  Calculate the total amount received

  • issue price × number of shares issued

• STEP 4
  Calculate the increase in the share capital and share premium

  • increase in share capital = nominal value × number of shares issued

  • increase in share premium can be calculated in two different ways

    • share premium per share × number of shares issued

    • total amount received - increase in share capital

• STEP 5
  Make the journal entries

  • Debit the bank account with the total amount received

  • Credit the share capital account

  • Credit the share premium account if the issue is at a premium

Bonus issue of shares

What is a bonus issue of shares?

• A bonus issue involves existing shareholders being given new shares, for free, based on the number they currently hold

  • E.g. two new shares might be given for every five shares the shareholders currently hold

• The company uses their reserves to issue the shares

• The reserves should be maintained in their most flexible form

  • This means the capital reserves should be used first

    • Use the share premium account

  • Use the revenue reserves only if the balance of the share premium account is not big enough to cover the issue

    • Use the retained earnings or general reserve

What are the advantages of a bonus issue of shares?

• A bonus issue keeps shareholders satisfied

  • Shareholders are rewarded with new shares

  • The company might choose to do this if they do not have the cash funds to pay dividends

• A bonus issue makes effective use of capital reserves

• Control is not diluted

  • The shares are given to existing shareholders

What are the disadvantages of a bonus issue of shares?

• A bonus issue does not generate any new cash

  • It does not help the cash flow

  • It might reduce future dividend payments

• It uses up some of the company's reserves

• Potential reduction in earnings per share

  • The more shares issued, the less earnings per share

How do I make the journal entries for a bonus issue of shares?

• STEP 1
  Calculate the number of issued shares before the bonus issue

  • share capital ÷ nominal value

• STEP 2
  Calculate the number of new shares issued

  • Use the ratio given in the question

    • e.g. if two shares are issued for every nine held then divide the current number of shares by nine and multiply by two

• STEP 3
  Calculate the increase in the share capital

  • nominal value × number of shares issued

• STEP 4
  Calculate the decrease in the share premium and retained earnings

  • Use the share premium to cover the full amount of the transaction if possible

  • Otherwise, use as much as possible and use the retained earnings for the remaining amount

• STEP 5
  Make the journal entries

  • Debit the share premium account

  • Debit the retained earnings account

  • Credit the share capital account