In the case of successful companies g if substantial reserves have been accumulated out of profits, it is common for such reserves to be capitalised by the issue to the shareholders of bonus shares fully paid up.
Capitalisation of reserves may be brought about in any one of the two ways:
(1) By declaring a dividend or bonus to shareholders out of the Reserve Fund and utilising the same in making the existing partly-paid shares fully paid; or
(2) By satisfying the bonus declared as payable from the Reserve Fund by the issue of new shares considered as fully paid.
The capitalisation of reserves benefits the company in as much as the past accumulated profits are permanently retained in the business. Further, where the Reserve Fund is allowed to get merged in the general assets of the company, the Bonus Shares would help to adjust the share capital to a figure more on a level with the actual capital employed in the business. The paid-up capital is increased by the issue of bonus shares although the profits will remain practically at about the previous level; the percentage of dividend must necessarily by reduced, whereas the actual return to the individual shareholder will remain just the same.
The shareholders will remain satisfied with such a procedure, as they can easily realise their Bonus Shares, if they so desire. Besides, it tends to bring up the market value of those shares, at a premium.
In connection with the capitalisation of reserves, the auditor should see that there are profits available for distribution, and the dividend or bonus as proposed by the Director is duly sanctioned by a resolution of the members. He should inspect the Articles to ascertain that the company is empowered to issue ‘bonus” shares. The necessary entries in the financial records as also in the Share Registers should be checked. He should further see that the issue of new shares does not increase the share capital beyond the authorised capital, as otherwise the necessary resolution for increasing the authorised capital has to be passed.