Share repurchases and scrip issues - Scrip and bonus issues ...

Learning Outcomes

After reading this article, you will be able to explain the mechanics of scrip dividends and bonus (scrip) issues, distinguish between scrip dividends and cash alternatives, and outline the impact of these strategies on shareholders and company equity. You will also understand reasons for share repurchases, advantages, and potential implications for shareholder wealth and reported metrics, as required for ACCA Financial Management (FM) exam questions.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the procedures, rationale, and implications of share repurchases and scrip/bonus issues. In your revision, pay special attention to:

• The mechanics and implications of scrip dividends and bonus issues
• The differences between scrip dividends and cash dividends
• The process and effects of share repurchase (buybacks) as a distribution alternative
• The impact of these actions on share capital, reserves, and reported shareholder metrics (EPS, NAV per share, etc.)
• The reasons for using scrip, bonus issues, and repurchases in capital management
• Practical and theoretical influences on dividend and share buyback policy

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the main difference between a scrip dividend and a bonus (scrip) issue?
2. Which of the following best describes the typical reason for a listed company to undertake a share repurchase? a) Reduce taxable income
   b) Increase the reported earnings per share (EPS)
   c) Avoid giving cash dividends
   d) Increase the number of shareholders
3. True or false? A bonus issue increases share capital but reduces the total equity of a company.
4. Briefly outline one advantage for shareholders of choosing a scrip dividend instead of a cash dividend.
5. What financial statement effect occurs when a company buys back its own shares and cancels them?

Introduction

Corporate distributions to shareholders take several forms, of which traditional cash dividends are the most common. However, companies may also reward shareholders through share repurchases and non-cash alternatives, such as scrip dividends and bonus issues. Understanding the mechanics and effects of scrip dividends, bonus issues, and share buybacks is important for decision-making and for ACCA FM exam success.

These alternatives to cash dividends offer management flexibility in capital structure, meet varying shareholder preferences, and may influence headline financial ratios. This article explains the principles and practice of scrip and bonus (scrip) issues, and outlines the workings of share repurchase programs.

Key Term: Scrip Dividend
A dividend where shareholders are offered the choice to receive additional shares instead of (or as well as) a cash dividend.

Key Term: Bonus (Scrip) Issue
An issue of fully paid new shares to existing shareholders, free of cost, by capitalizing a company's reserves. This increases share capital without raising new funds.

Key Term: Share Repurchase (Buyback)
The process by which a company buys back its own shares from existing shareholders, often to cancel them, thus reducing the number of shares in issue.

SCRIP DIVIDENDS AND BONUS ISSUES

Scrip Dividend Mechanics

A scrip dividend allows each shareholder to receive new shares in the company instead of a cash payout. The board declares the total dividend, giving shareholders the option to accept shares or, in some cases, cash. The number of shares offered is typically based on the current market value or a fixed price set by the company.

Key features:

• Scrip dividends are usually offered when a company wants to conserve cash or offer a tax-efficient alternative to shareholders.
• Shareholders receiving shares increase their holdings without paying transaction costs.
• The company’s total equity remains unchanged; retained earnings are transferred to share capital and share premium.

Comparison with cash dividend:

• Scrip dividends do not reduce company cash balances.
• Shareholders who opt for scrip dividends may later benefit from selling additional shares when cash is needed.

Bonus (Scrip) Issue Mechanics

A bonus issue, also called a capitalisation or scrip issue, involves issuing additional fully paid shares to existing shareholders in proportion to their current holdings, without any payment required from shareholders.

Key features:

• Common ratios include 1-for-5 or 1-for-10, meaning one new share for every five or ten held.
• Bonus issues convert a company’s reserves (often retained earnings or share premium) into permanent share capital.
• There is no change in the total equity; it is simply reclassified within reserves and share capital.

Practical impacts:

• Individual shareholders receive more shares, but each share now represents a smaller proportion of the company’s equity.
• The share price usually falls in proportion to the increase in the number of shares, so total market value per shareholder remains approximately the same.
• Bonus issues may improve liquidity by increasing the number of shares in circulation and reducing their market price per share.

Exam Warning Do not confuse a scrip dividend (an optional stock dividend in place of a cash dividend) with a bonus (scrip) issue (a free share issue to all shareholders with no cash alternative). They differ in mechanics and financial statement effects.

Effects on Financial Statements

Scrip and bonus issues have distinct entries:

• Scrip dividend: Decrease retained earnings by the dividend amount, increase share capital and, if needed, share premium.
• Bonus issue: Transfer the total issue value from reserves (retained earnings, share premium, or revaluation reserve) to share capital.

In both, total equity is unchanged. However, the composition within equity changes, and the number of shares in issue increases.

Reasons for Scrip and Bonus Issues

Companies may use scrip dividends or bonus issues for several reasons:

• Preserve cash for working capital or investment.
• Give shareholders flexibility, especially those preferring to reinvest rather than take cash dividends.
• Signal confidence in future profitability (bonus issues).
• Increase share liquidity by reducing market price per share.

SHARE REPURCHASES (BUYBACKS)

Mechanics of Share Buybacks

A share repurchase, or buyback, is when a company buys its own shares from shareholders, often through a market purchase or tender offer. Purchased shares are usually cancelled, reducing the number of shares in issue.

Key effects:

• Total number of shares falls, so earnings per share (EPS) and net asset value per share may rise—assuming profits and assets remain unchanged.
• Distribution to shareholders is effectively in the form of capital, not income.

Accounting entries:

• Reduce cash (or increase debt if funded by borrowing).
• Reduce share capital (and possibly share premium).
• Reserves may also be reduced if purchase price exceeds nominal value of the shares.

Revision Tip For the exam, remember: scrip and bonus issues reclassify equity, without affecting cash, while share repurchases reduce both equity and cash.

Motivations for Share Buybacks

Common reasons include:

• To return surplus cash to shareholders (as an alternative to dividends).
• To increase reported EPS or improve other share-related financial ratios.
• To manage capital structure (increase gearing).
• To signal management’s confidence if the market undervalues the company’s shares.

Effects on Shareholders

• Shareholders who sell receive cash (often subject to capital gains tax).
• Remaining shareholders own a larger percentage of the company, as total shares in issue decreases.

Regulatory notes:

• Legal restrictions apply; only certain reserves (typically distributable profits) may fund buybacks.
• Buybacks may not be possible if the company lacks sufficient distributable reserves.

Worked Example 1.1

A company has 10 million shares in issue, trading at $5 each, and declares a 1-for-10 bonus issue. What is the new number of shares, and what would be the expected share price after the bonus issue, assuming the total equity market value remains unchanged?

Answer:
After the 1-for-10 bonus issue, total shares increase to 11 million. If the total market value remains at $50 million (10 million x $5), then the new price per share will be $50 million / 11 million = $4.55. Each shareholder has more shares, but their total investment value is unchanged.

Worked Example 1.2

XYZ plc offers shareholders a scrip dividend: for every 20 shares held, the shareholder can receive 1 additional share or a cash dividend of $0.25 per share. A shareholder owns 2,000 shares and chooses to take the scrip dividend option.

Answer:
The shareholder receives 2,000 / 20 = 100 new shares. The total shares owned increases to 2,100. No cash is received, and their percentage of ownership remains broadly the same as other shareholders who made the same choice.

Worked Example 1.3

A company repurchases and cancels 500,000 of its own 10 million outstanding shares at $6 per share. What impact does this have on reported earnings per share (EPS), assuming net profit remains at $4 million?

Answer:
Shares in issue after buyback: 10 million – 0.5 million = 9.5 million. EPS before: $4 million / 10 million = $0.40. EPS after: $4 million / 9.5 million ≈ $0.42. EPS increases due to fewer shares, even though profits are unchanged.

Summary

Scrip dividends and bonus issues both provide additional shares to shareholders, but differ in mechanics: scrip dividends are an alternative to cash dividends, while bonus issues involve capitalising reserves. Neither affects company cash balances. Share repurchases decrease share count and equity, may improve financial ratios, and provide an alternative to dividends for distributing surplus cash. Understanding these distribution methods supports exam success and financial management decision-making.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain scrip dividend and bonus issue mechanics and their accounting effects
• Distinguish between scrip dividends and bonus issues
• Discuss the rationale and impact of bonus and scrip issue choices
• Outline the process, motives, and consequences of share repurchases (buybacks)
• State how these transactions affect key financial statement measures and ratios

Key Terms and Concepts

• Scrip Dividend
• Bonus (Scrip) Issue
• Share Repurchase (Buyback)