Bonus Shares and Buy-back of Shares: Meaning, Conditions and Accounting Treatment (Overview) Questions

Question 1

Define bonus shares.

Accepted Answer

Bonus shares are shares issued free of cost to existing shareholders by capitalising eligible reserves in a specified ratio.

Question 2

What is buy-back of shares?

Accepted Answer

Buy-back of shares means the company repurchases its own shares from shareholders and cancels them, reducing share capital.

Question 3

State one objective of bonus issue.

Accepted Answer

One objective of bonus issue is to capitalise accumulated profits/reserves without cash outflow.

Question 4

State one objective of buy-back of shares.

Accepted Answer

One objective of buy-back is to return surplus cash to shareholders and improve EPS by reducing shares outstanding.

Question 5

What is Capital Redemption Reserve (CRR)?

Accepted Answer

Capital Redemption Reserve is a reserve created out of free reserves to maintain capital when share capital is reduced due to buy-back/redemption.

Question 6

Bonus shares bring fresh funds to the company.

Accepted Answer

False. Bonus shares do not bring fresh funds; they are issued by capitalising reserves.

Question 7

Explain sources out of which bonus shares can be issued (any three).

Accepted Answer

Bonus shares can be issued by capitalising eligible reserves such as (any three):

- **General Reserve**
- **Profit & Loss (Surplus)** / retained earnings
- **Securities Premium** (as permitted)
- **Capital Redemption Reserve** (where permitted)

Thus, reserves are converted into share capital through bonus issue.

Question 8

State any three conditions for issue of bonus shares (exam points).

Accepted Answer

Conditions for bonus issue (any three):

- authorised as per Articles/Board/Shareholders (as applicable)
- issued out of **eligible reserves** only
- no default in statutory dues/interest (as per rules)
- partly paid shares (if any) should be made fully paid before bonus

Write “as per Companies Act/rules” in exams.

Question 9

Pass journal entries for bonus issue (reserve transfer and issue of bonus shares).

Accepted Answer

Journal entries:

1) **Eligible Reserve A/c Dr** (e.g., General Reserve/P&L/Securities Premium)  
  To **Bonus Issue A/c**

2) **Bonus Issue A/c Dr**  
  To **Share Capital A/c**

(Being reserves capitalised and bonus shares issued.)

Question 10

Differentiate between bonus issue and buy-back of shares (any three points).

Accepted Answer

Bonus issue vs buy-back:

| Basis | **Bonus issue** | **Buy-back** |
|---|---|---|
| Share capital | increases | decreases |
| Cash flow | no cash outflow | cash outflow |
| Shares outstanding | increases | decreases |

Hence, bonus capitalises reserves while buy-back returns cash and reduces capital.

Question 11

How do you compute bonus shares to be issued from a given ratio? Explain with a short example.

Accepted Answer

Bonus ratio tells how many new shares are issued for existing shares.

Example: Bonus ratio **1:5** means 1 bonus share for every 5 existing shares.
If a shareholder holds 1,000 shares:
- Bonus shares = 1,000 ÷ 5 = **200** shares

| Bonus ratio | Meaning |
|---|---|
| 1:5 | 1 new for 5 existing |

Thus, Bonus shares = Existing shares × (Bonus / Existing in ratio).

Question 12

State the journal entry for creation of Capital Redemption Reserve (CRR) in buy-back and explain why it is created (short).

Accepted Answer

When buy-back is made out of **free reserves**, CRR is created:

**Free Reserves A/c Dr**  
  To **Capital Redemption Reserve (CRR) A/c**

Reason: buy-back reduces share capital; transferring an equivalent amount to **CRR** helps **maintain capital base** and protect creditors.

Flow: Buy-back → Capital reduced → Transfer to CRR → Capital maintained

Question 13

Explain buy-back of shares and the need to create Capital Redemption Reserve (CRR) (use a flow/table).

Accepted Answer

**Buy-back** is repurchase and cancellation of a company’s own shares. It reduces share capital.

### Why CRR is created
When buy-back is made out of **free reserves**, creditors’ protection requires maintaining capital base. So an amount equal to the nominal value of shares bought back is transferred from free reserves to **CRR**.

Flow (write):
Free reserves used → Share capital reduced → Transfer to **CRR** → Capital base maintained

| Step | **Effect** |
|---|---|
| Buy-back | reduces share capital |
| Create CRR | maintains capital/protects creditors |

### Conclusion
CRR ensures the company does not reduce its capital base unfairly when buy-back is financed from free reserves.

Question 14

Explain the accounting treatment of premium on buy-back (overview) and its adjustment.

Accepted Answer

If shares are bought back at a price higher than face value, the excess is **premium on buy-back**.

### Treatment (overview)
- Share capital is debited with **face value**.
- Premium on buy-back is debited separately.
- Premium is adjusted against **Securities Premium** or **free reserves** as permitted.

| Component | **Debited to** |
|---|---|
| Face value | Share Capital A/c |
| Premium | Premium on Buy-back A/c (then adjusted) |

### Conclusion
Premium on buy-back is a cost of capital reduction and is written off using permitted reserves.

Question 15

Explain bonus issue with objectives and accounting entries (exam-style).

Accepted Answer

**Bonus issue** means issuing additional shares free to existing shareholders by capitalising reserves.

### Objectives
- **capitalisation of profits**
- reward shareholders without cash outflow
- improve marketability/wider distribution

### Accounting entries
1) Reserve A/c Dr → To **Bonus Issue A/c**
2) Bonus Issue A/c Dr → To **Share Capital A/c**

| Point | **Keyword** |
|---|---|
| Nature | capitalisation |
| Cash flow | no cash inflow |

### Conclusion
Bonus issue strengthens paid-up capital by converting reserves into share capital without raising fresh funds.

Bonus Shares and Buy-back of Shares: Meaning, Conditions and Accounting Treatment (Overview)

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