Rights Issue, Bonus Shares & Debentures: SEBI Rules and Accounting
Rights Issue
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. 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, or let expire. This maintains proportional ownership and prevents dilution for participating shareholders, with the discount designed so that the cum-rights 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, enabling faster fundraising without extensive marketing or regulatory scrutiny for new investors. Public issues (follow-on public offers) invite the general public to subscribe via stock exchanges and involve higher costs for prospectuses, roadshows, and underwriting to attract broad participation. Key differences include:
- Audience: existing shareholders vs. new/general public
- Pricing: discounted vs. market-driven
- Speed: rights issues typically faster
- Costs: lower for rights issues
- Dilution control: better preserved in rights issues
[2][3][5][7]
Advantages of Rights Issue
Rights issues enable rapid capital infusion at lower costs by bypassing underwriting fees and public advertising expenses common in public issues. Existing shareholders retain control and avoid dilution by participating at a discounted price, while non-participants can sell renounceable rights for value. Companies benefit from a natural hedge against issue expenses, a loyal investor base, and preservation of tax loss carryforwards without changes in control. [3][5][1][2]
Advantages of Rights Issue (Repeated Section)
Rights issues provide companies with quick, cost-effective capital raising by avoiding underwriting fees, roadshows, and extensive marketing required for public issues. Existing shareholders maintain proportional ownership without dilution if they subscribe, and can sell renounceable rights for profit due to the discount. Rights issues can signal confidence to the market, preserve tax benefits such as loss carryforwards, and ensure faster fund availability compared to broader public offerings. [1][2][3][4]
SEBI Guidelines Regarding Rights Issue
SEBI’s ICDR Amendment Regulations 2025, effective March 3, 2025, require all listed issuers to comply with ICDR norms regardless of issue size, removing the prior INR 500 million threshold and 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 is calculated as:
V = (N × (MP − IP)) / (N + 1)
where N is the number of existing shares required for one new right share, MP is the market price cum-rights, and IP is the issue price. This determines the premium for trading rights. The ex-rights price is:
Ex-rights price = ((N × MP) + IP) / (N + 1)
These formulas balance cum-rights value with new shares. Shareholders assess subscription viability by comparing the theoretical value against market-traded rights. [7][8][9]
Bonus Shares
Bonus shares are fully paid-up additional shares issued to existing shareholders gratis, capitalizing free reserves or share premium to reward loyalty without cash outflow. [10][1]
Objects of Bonus Issue
Companies issue bonus shares to capitalize accumulated reserves arising from genuine profits, conserving cash for operations when dividends would strain liquidity. Bonus issues enhance market liquidity by increasing the number of shares, improve trading affordability, and signal strong financial health to attract investors. [11][10]
Advantages and Disadvantages of Bonus Shares
Advantages:
- No cash outflow or dilution for the company, preserving working capital. [11]
- Boosts share liquidity and affordability, potentially improving market perception. [11]
- Rewards shareholders, improves EPS perception after adjustment, and helps retain talent via stock-option-linked incentives. [10]
Disadvantages:
- Increases outstanding shares, reducing future EPS and dividend yield per share. [11]
- No fresh capital inflow, limiting funds available for growth. [11]
- May signal insufficient cash for dividends, potentially impacting investor sentiment. [12]
Types of Bonus Issue
Common ratios include 1:1 (one bonus share per held share), 1:2 (one per two shares), or 3:2, determined by reserves available and shareholder equity. Types capitalize funds from free reserves, securities premium, or capital redemption reserve, excluding 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 five days of the board meeting. Bonus issues must use free reserves created from genuine profits or cash-collected share premium, prohibiting use of revaluation reserves or substitute dividends, consistent with ICDR and LODR rules. [12][13]
Accounting Treatment for Bonus and Rights Issues
For bonus issues, debit free reserves/securities premium/capital redemption reserve and credit share capital by the nominal value of issued shares. For rights issues, credit share capital with the face value received and credit securities premium with the excess over face value from subscriptions. No cash entry is recorded for bonus issues; rights issues record cash inflow proportionally. [8][1][10]
Debentures: Meaning and Characteristics
Debentures represent a company’s long-term debt instrument, acknowledging borrowed funds with a promise to repay principal at maturity plus fixed interest periodically. Under the Companies Act 2013, they qualify as bonds or instruments evidencing debt and may be secured or unsecured by assets. Key characteristics include fixed interest irrespective of profits, no voting rights for holders (creditors, not owners), tradability on exchanges, long-term maturity (commonly 5–10 years), and priority repayment over equity in liquidation but after secured creditors. [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 assets)
- Unsecured (based on issuer creditworthiness)
- Redeemable (repayable at maturity)
- Irredeemable or perpetual
- Convertible and non-convertible
- Registered (named holders) and bearer (possession-based)
- First mortgage and second mortgage (based on charge priority)
[2][5][6]
Difference Between a Share and a Debenture
Shares confer ownership with variable dividends from profits and voting rights, while debentures provide creditor status with fixed interest irrespective of profits and no ownership or voting rights. Shares offer unlimited upside potential but carry higher risk with no guaranteed repayment; debentures ensure periodic interest and principal repayment, are secured or unsecured, and rank above shares in liquidation. Funds from share issuance become permanent equity; debenture proceeds remain repayable debt. [3][6][2]
Issue of Debentures at Par
Issuing at par means allotting debentures at face value (e.g., 100 each), with cash received equaling nominal value credited fully to the Debentures Account. Typical 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., A 100 face at A 110). The excess is credited to the Securities Premium Account for permitted future uses. Journal: Debit Bank A/c (total received), Credit Debentures A/c (face value), Credit Securities Premium A/c (excess); this enhances capital without dilution. [11][1]
Issue of Debentures at Discount
Debentures issued at a discount are below face value (e.g., A 100 face at A 95). The difference is recorded in the Discount on Issue of Debentures Account (a deferred expense) and is amortized over the life of the debentures. Journal: Debit Bank A/c (proceeds), Debit Discount on Issue of Debentures A/c (difference), Credit Debentures A/c (face value). Amortization increases the effective interest cost. [11][1]
Calls in Arrears on Debentures
Calls in arrears arise when debenture holders delay installment payments on partly paid debentures. These are recorded as receivables, possibly with interest or penalties. Journal: Debit Calls-in-Arrears A/c, Credit Call Amount; such amounts may be forfeited if unpaid as per terms. [1]
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Calls in Advance on Debentures
Calls in advance occur when holders pay future installments early; the amount is treated as a liability with interest effectively earned by the company. Journal: Debit Bank A/c, Credit Calls-in-Advance A/c; the balance is adjusted against future calls. [1]
Over-Subscription of Debentures
Over-subscription happens when applications exceed the number of debentures offered. The company allots proportionally or refunds the excess according to prospectus terms. Accounting: Debit Bank A/c (total receipts), adjust allotments, Credit Debentures A/c (issued amount), and refund excess amounts as required. [1]
Issue of Debentures for Consideration Other Than Cash
Debentures may be issued against non-cash assets (e.g., machinery or supplier consideration), valued at fair market price. Typical journal when issued for machinery: Debit Machinery A/c, Credit Debentures A/c (face value), Credit Securities Premium A/c (excess). Such transactions should reflect arm’s length valuation. [2][1]
Treatment of Discount on Issue of Debentures
Discount on issue of debentures arises when debentures are issued below face value. The discount is a loss to the company and is recorded as a deferred expense called “Discount on Issue of Debentures,” which is written off over the life of the debentures (commonly within the operating cycle) through the profit and loss account. This amortization increases the effective borrowing cost. [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
There are two main methods for accounting for debentures issued as collateral security:
- No Entry Method: No journal entry is recorded when debentures are issued purely as collateral because no funds are received and no liability is immediately created. 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]
- Debentures Suspense Account Method: The company records the issue 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 the suspense in the notes, reflecting the contingent nature of the liability. [3][1]
Interest is not paid on debentures issued as collateral; the company’s liability is the loan taken, not the debentures themselves unless default occurs. [4]