Corporate Finance Mechanisms: Rights Issues, Bonus Shares, and Debentures

Rights Issue: Capital Raising for Existing Shareholders

A Rights Issue allows a company to raise capital by offering existing shareholders the opportunity to purchase additional shares at a discounted price, proportional to their current holdings. This mechanism is typically used to fund expansion or debt reduction. Shareholders receive rights entitlements, which they can:

• Exercise: By paying for new shares within a limited period.
• Renounce: By selling them on the market.
• Let Expire: If they choose not to participate or sell.

Participation maintains proportional ownership and prevents dilution for participating shareholders. The discount ensures the cum-right share value equals the post-issue ex-right value. [1][2][4][8]

Distinction Between Rights Issue and Public Issue

Rights Issues target only existing shareholders with a preferential discounted offer, ensuring quick fundraising without extensive marketing or regulatory scrutiny for new investors. Public Issues, or Follow-on Public Offers (FPOs), invite the general public to subscribe via stock exchanges, involving higher costs for prospectuses, roadshows, and underwriting to attract broad participation.

Key differences include:

• Audience: Existing shareholders vs. New shareholders (General Public).
• Pricing: Discounted vs. Market-driven.
• Speed: Faster for rights issues.
• Costs: Lower for rights issues (bypassing underwriting fees).
• Dilution Control: Better preserved in rights issues for participants.

[2][3][5][7]

Advantages of a Rights Issue

Rights issues enable rapid capital infusion at lower costs, bypassing underwriting fees and public advertising expenses common in public issues. Specific benefits include:

• Existing shareholders retain control and avoid dilution by participating at a bargain price.
• Non-participants can sell renounceable rights for value.
• Companies benefit from a natural hedge against issue expenses.
• Preservation of a loyal investor base.
• Preservation of tax loss carryforwards without control changes.

[3][5][1][2]

SEBI Guidelines Regarding Rights Issues

SEBI's ICDR Amendment Regulations 2025, effective March 3, 2025, mandate all listed issuers comply with ICDR norms regardless of issue size, removing the prior INR 500 million threshold, while barring firms under stock exchange disciplinary suspension. A July 2025 circular sets timelines, effective April 7, 2025, for board-approved rights issues, streamlining processes for efficiency and investor protection. Key requirements include detailed disclosures, proportionate offers to shareholders, and renounceable rights within specified periods. [5][6]

Valuation of Rights

The theoretical value of a right ($$ V $$) is calculated as:

$$ V = rac{N \times (MP - IP)}{N + 1} $$

Where:

• $$ N $$ is existing shares needed for one right share.
• $$ MP $$ is market price cum-rights.
• $$ IP $$ is issue price.

This formula determines the premium for trading rights. The Ex-rights price equals $$ rac{(N \times MP) + IP}{N + 1} $$, balancing cum-rights value with new shares. Shareholders assess subscription viability by comparing this value against market-traded rights. [7][8][9]

Bonus Shares: Rewarding Shareholders Through Capitalization

Definition of Bonus Shares

Bonus shares involve issuing fully paid-up additional shares to existing shareholders gratis (free of charge). This process capitalizes free reserves or share premium accounts to reward loyalty without requiring a cash outflow from the company. [10][1]

Objects of Bonus Issue

Companies issue bonus shares primarily to capitalize accumulated reserves derived from genuine profits, thereby conserving cash for operations when dividends would strain liquidity. Other objectives include:

• Enhancing market liquidity by increasing the share count.
• Improving trading affordability (due to lower per-share price post-issue).
• Signaling strong financial health to attract investors.

[11][10]

Advantages and Disadvantages of Bonus Shares

Advantages:

• No cash dilution for the company, preserving working capital. [11]
• Boosts share liquidity and affordability, potentially raising the market price. [11]
• Rewards shareholders, improves Earnings Per Share (EPS) perception post-adjustment, and helps retain talent via stock options. [10]

Disadvantages:

• Increases outstanding shares, reducing future EPS and dividend yield per share. [11]
• No fresh capital inflow, limiting growth funding. [11]
• Potential signaling of insufficient cash for dividends, impacting investor sentiment. [12]

Types of Bonus Issue

Common ratios include 1:1 (one bonus per held share), 1:2 (one per two shares), or 3:2, based on available reserves and shareholder equity. Bonus issues capitalize funds from free reserves, securities premium, or capital redemption reserve, but exclude revaluation gains. [13][1][10]

Latest SEBI Guidelines on Bonus Issue

SEBI's September 2024 circular, effective October 1, 2024, mandates T+2 trading post-record date (T), with deemed allotment on T+1 and in-principle exchange approval within 5 days of the board meeting. Bonus issues must use free reserves from genuine profits or cash-collected share premium, prohibiting the use of revaluation reserves or serving as dividend substitutes, per ongoing ICDR and LODR rules. [12][13]

Debentures: Debt Instruments and Accounting Treatment

Meaning, Definition, and Characteristics of Debentures

Debentures represent a company's long-term debt instrument, acknowledging borrowed funds with a promise to repay the principal at maturity plus fixed interest periodically. Under the Companies Act 2013, they qualify as bonds or instruments evidencing debt, which may be secured or unsecured by assets.

Key characteristics include:

• Fixed interest regardless of profits.
• No voting rights for holders (as creditors, not owners).
• Tradability on exchanges.
• Long-term maturity (typically 5–10 years).
• Priority repayment over shares in liquidation (but after secured debts).

[1][2][3][4]

Purpose and Types of Debentures

Companies issue debentures to raise medium-to-long-term capital for expansion, debt refinancing, or projects without diluting ownership, leveraging the tax-deductibility of fixed interest. Types include:

• Secured: Mortgaged against specific assets.
• Unsecured (Naked): Based solely on creditworthiness.
• Redeemable: Repayable at maturity.
• Irredeemable (Perpetual): No fixed maturity date.
• Convertible: Can be converted into equity shares.
• Non-convertible: Cannot be converted into equity.
• Registered: Held by named holders.
• Bearer: Possession-based ownership (anonymous).
• First/Second Mortgage: Based on charge priority.

[2][5][6]

Difference Between a Share and a Debenture

[3][6][2]

Issue of Debentures at Par, Premium, and Discount

Issue of Debentures at Par

Issuing at par means allotting debentures at face value (e.g., ₹100 each). The cash received equals the nominal value credited fully to the Debentures Account. Journal Entry: Debit Bank A/c, Credit Debentures A/c. Interest accrues separately. [1]

Issue of Debentures at Premium

At premium, debentures are issued above face value (e.g., ₹100 face at ₹110). The excess is credited to the Securities Premium Account for future use, similar to equity premiums. This enhances capital without dilution. Journal Entry: Debit Bank A/c (total received), Credit Debentures A/c (face), Credit Securities Premium A/c (excess). [11][1]

Issue of Debentures at Discount

Issued at a discount below face value (e.g., ₹100 face at ₹95). The difference is treated as a loss (Debenture Discount Account) and amortized over the life of the debentures via interest. This impacts the effective interest rate upward. Journal Entry: Debit Bank A/c (proceeds), Debit Discount on Issue of Debentures A/c (difference), Credit Debentures A/c (face). [11][1]

Calls in Arrears and Calls in Advance on Debentures

Calls in Arrears on Debentures

Calls in arrears arise when debenture holders delay installment payments on partly paid debentures. This is recorded as a receivable with interest/penalties. Journal Entry: Debit Calls-in-Arrears A/c, Credit Call Amount. Debentures may be forfeited if unpaid per terms. [1]

Calls in Advance on Debentures

Calls in advance occur when holders pay future installments early. This is treated as a liability, and the company pays interest on the advance. Journal Entry: Debit Bank A/c, Credit Calls-in-Advance A/c. This amount is adjusted against future calls. [1]

Over-Subscription of Debentures

Over-subscription happens when applications exceed the offered debentures. The company allots proportionally or refunds the excess per prospectus terms. Journal Entry: Debit Bank A/c (total), adjust allotments, Credit Debentures A/c (issued amount), refund excess. [1]

Issue of Debentures for Consideration Other Than Cash

Debentures issued against non-cash assets like machinery or purchases are valued at fair market price, debiting asset/supplier accounts. Example Journal Entry (for machinery): Debit Machinery A/c, Credit Debentures A/c (face), Credit Securities Premium (if applicable). This verifies an arm's length transaction. [2][1]

Treatment of Discount on Issue of Debentures

The discount on the issue of debentures is a loss to the company and is shown as a deferred expense called "Discount on Issue of Debentures." This amount is written off (amortized) over the life of the debentures, usually within the operating cycle, in the profit and loss account. This amortization increases the effective cost of borrowing. [1][4]

Issue of Debentures as Collateral Security

Debentures issued as collateral security are additional securities provided to a lender besides the primary security (such as a mortgage or fixed asset) when a company takes a loan. The lender can claim the security through these debentures only if the company defaults on the loan repayment and the primary security is insufficient to cover the debt. [1][4]

Accounting Treatment for Collateral Security

There are two main methods for accounting for debentures issued as collateral security:

1. No Entry Method:

   No journal entry is recorded when debentures are issued as collateral because no actual funds are received, and no liability is immediately created. Instead, a note is made in the balance sheet under long-term borrowings indicating the loan secured by the issue of debentures as collateral security. [2][6][1]

2. Debentures Suspense Account Method:

   The company records the issue of debentures by debiting a "Debentures Suspense Account" and crediting the "Debentures Account." This entry appears in the balance sheet under long-term liabilities but is shown net of suspense in the notes. This reflects the contingent nature of the liability. [3][1]

Interest is not paid on debentures issued as collateral; the company's liability is on the loan taken, not the debentures themselves, unless default occurs. [4]

Summary of Accounting Treatment

For a Bonus Issue, debit free reserves/securities premium/capital redemption reserve and credit share capital by the nominal value of issued shares.

A Rights Issue credits share capital with the face value received and securities premium with the excess over face value from subscriptions. Rights issues record cash inflow proportionally, whereas bonus issues involve no cash entry. [8][1][10]