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Bonus issues and rights issues
Edexcel IAL Accounting · WAC12 Corporate and Management Accounting
A bonus issue gives existing shareholders free shares; a rights issue sells new shares to them at a discount. One raises no cash, the other does, and the entries are different.
Bonus issue
A bonus (scrip, capitalisation) issue gives existing shareholders extra shares in proportion to their holding, for example 1 for 4, free of charge. It is paid for by converting reserves into share capital.
Journal: Dr Share premium (or revaluation reserve, capital redemption reserve, then retained earnings), Cr Ordinary share capital.
Effects: no cash raised; total equity unchanged; more shares, so the market price per share usually falls; capital reserves are normally used first so revenue reserves stay available for dividends.
Why do it? To bring the share price into a more marketable range, to signal confidence, and to show that reserves are permanently invested in the business.
Rights issue
A rights issue offers existing shareholders the right to buy new shares in proportion to their holding, usually at a discount to the market price.
Journal: Dr Bank, Cr Ordinary share capital (nominal), Cr Share premium (excess).
Advantages: cheaper and quicker than a public issue; control stays with existing shareholders if they take up their rights; raises cash without increasing gearing (in fact gearing falls).
Disadvantages: shareholders may not have the cash; the discount dilutes the value per share; the amount raised is limited to what existing shareholders will pay.
Theoretical ex-rights price
After a rights issue the market price tends to settle at a weighted average:
TERP = (value of old shares + cash from new shares) / total shares after the issue.
For example, 4 shares at £3.00 plus 1 new share at £2.00: (12 + 2) / 5 = £2.80.
Comparing the two
| Bonus issue | Rights issue | |
|---|---|---|
| Cash raised | None | Yes |
| Price paid by shareholders | Nothing | Usually below market price |
| Effect on reserves | Reserves fall | Share premium rises (if above nominal) |
| Effect on total equity | No change | Increases by the cash raised |
| Effect on gearing | No change | Falls |
Worked example
A company has 8,000,000 £1 ordinary shares and a share premium of £1,500,000. It makes a 1 for 4 bonus issue, using share premium first and then retained earnings. Give the journal.
- Bonus shares = 8,000,000 / 4 = 2,000,000, nominal value £2,000,000
- Use share premium £1,500,000 first, then retained earnings £500,000
- Dr Share premium £1,500,000; Dr Retained earnings £500,000; Cr Ordinary share capital £2,000,000
Answer: Ordinary share capital rises to £10,000,000; share premium is used up; retained earnings fall by £500,000
Check yourself
- A company has 6,000,000 ordinary shares. It makes a 2 for 3 bonus issue. How many shares are in issue afterwards?
Show answer
10000000 shares. Bonus shares = 6,000,000 x 2/3 = 4,000,000; total = 10,000,000.
- A company with 5,000,000 £1 shares makes a 1 for 5 rights issue at £1.60. How much cash is raised if all rights are taken up?
Show answer
£1600000. New shares = 1,000,000; cash = 1,000,000 x £1.60 = £1,600,000.
- In that rights issue (1,000,000 new £1 shares at £1.60), by how much does share premium increase?
Show answer
£600000. 1,000,000 x £0.60 = £600,000.
- A shareholder holds 3 shares worth £4.00 each. The company makes a 1 for 3 rights issue at £2.80. Calculate the theoretical ex-rights price.
Show answer
£3.70. (3 x 4.00 + 2.80) / 4 = £3.70.
- Which journal records a bonus issue paid from share premium?
- Dr Share premium, Cr Ordinary share capital
- Dr Bank, Cr Ordinary share capital
- Dr Ordinary share capital, Cr Share premium
- Dr Retained earnings, Cr Bank
Show answer
Dr Share premium, Cr Ordinary share capital. Reserves are capitalised into share capital; no cash moves.
- What is the effect of a rights issue on a company's gearing?
- Gearing rises, because debt increases
- Gearing is unchanged, because no cash is raised
- Gearing falls, because equity increases
- Gearing rises, because reserves fall
Show answer
Gearing falls, because equity increases. Equity rises with the cash raised while debt is unchanged, so the proportion of debt falls.
- What happens to total equity after a bonus issue?
- It stays the same
- It rises by the value of the bonus shares
- It falls by the value of the bonus shares
- It rises by the market value of the new shares
Show answer
It stays the same. Reserves fall and share capital rises by the same amount.
- Give two reasons why a company might choose a rights issue rather than an issue of shares to the general public.
Show answer
It is cheaper and quicker to arrange, with lower issue costs, and existing shareholders keep control because new shares go to them in proportion to their holdings.. Rights issues have lower issue costs and protect existing shareholders' control.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.