A bonus issue is an offer of free additional shares to existing shareholders. A company may decide to distribute additional shares as an alternative to dividend payout. These are the company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares. For example, a company may give one bonus share for every 2 shares held. You will be eligible for bonus shares if you’ve purchased the stocks before the ex-date. If you've purchased the shares on or after the ex-date, you will not be eligible for the bonus shares. You will need to own the shares in your demat account on the record date to be eligible for a bonus issue.
The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
For instance, if Investor A holds 200 shares of a company and a company declares a 4:1 bonus, that is for every 1 share, he gets 4 shares for free. That is, a total of 800 shares for free and his total holding will increase to 1000 shares.
If the price before the bonus issue was Rs. 500, this will now reduce to Rs. 100 after the bonus issue.
Market value before bonus (200 x 500 = Rs 100,000) = Market value after bonus (1000 x 100 = Rs 100,000)
Companies issue bonus shares to encourage retail participation and increase their equity base. When the price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company. Increase in the number of shares reduces the price per share. But the overall capital remains the same even after bonus shares are declared.
When the company issues bonus shares, since the profits or reserves of the company are converted into share capital, there is a ‘capitalisation’ of the profits. The company cannot charge the shareholders for the issue of the bonus shares. A sum that is equal to the value of the bonus issue, is adjusted against the profits or the reserve, and then transferred to the Equity Share Capital Account.
Stock Split gives rise to reduction in face value, while the face value stays as it is in case of a Bonus Issue.
Bonus Issue is paid out of the General Reserve of the company, while this is not the case for Stock Split.
Total paid up capital of the company increases in case of Bonus Issue, while it stays the same for Stock Split.
Bonus Issue is given as an alternative to Dividend, while Stock Split is announced to increase liquidity and reduce market price to make it more affordable to retail investors.