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Company Law and Practice · Distribution of Profits

Capitalisation of Profits and Bonus Shares under Section 63

Updated 11 October 2026 · Fact-checked

Capitalisation of profits means turning reserves into share capital by issuing fully paid-up bonus shares to members, free of cost. Section 63 allows it out of free reserves, securities premium or capital redemption reserve, but not revaluation reserve, and only if listed conditions are met. Check source, authority, defaults, then partly paid shares.

Understand Capitalisation of Profits and Bonus Shares

A company earns profits. It can pay them out as dividend, or keep them as reserves. Capitalisation of profits is a third route: the company converts reserves into share capital by issuing new, fully paid-up shares to existing members without taking any money. These are bonus shares.

No cash leaves the company. The reserves shrink and share capital grows by the same amount. Total net worth does not change. Each member holds more shares, but the value per share falls in theory, so a member's overall stake stays in the same proportion.

This is why bonus shares differ from dividend. Dividend is a distribution that is paid in cash. Section 63(3) says bonus shares cannot be issued in lieu of dividend. Section 123(5) allows capitalisation of profits for bonus shares even though dividend must otherwise be paid in cash.

Section 63(1) lets a company issue fully paid-up bonus shares to members, in any manner whatsoever, out of three sources: its free reserves, the securities premium account, or the capital redemption reserve account. The proviso bars capitalising reserves created by revaluation of assets, because those gains are not realised.

Section 63(2) then sets the conditions. Without them, no capitalisation is allowed. Examiners test the sources, the conditions and the bar on revaluation reserve again and again.

Key rules to remember

Permitted sources (Section 63(1))
Free reserves | Securities premium account | Capital redemption reserve account
Bonus shares must be fully paid-up. Reserves created by revaluation of assets cannot be capitalised.
Conditions for capitalisation (Section 63(2))
(a) Articles authorise; (b) Board recommends and general meeting authorises; (c) no default on interest or principal on fixed deposits or debt securities; (d) no default on employees' statutory dues (PF, gratuity, bonus); (e) partly paid shares made fully paid; (f) prescribed conditions complied with
All conditions must be met together. Failing any one blocks the issue.
No bonus in lieu of dividend (Section 63(3))
Bonus shares shall not be issued in lieu of dividend
Bonus issue cannot replace a dividend payment.
Accounting effect
Reserves reduced by the amount capitalised = Share capital increased by the same amount
Net worth is unchanged. Use this to check journal entries.
Bonus amount
Bonus shares issued = Existing shares × Bonus ratio
For a 1:2 bonus (one for every two held), new shares = existing shares ÷ 2. Amount capitalised = new shares × face value.
Other statutory links
Section 52(2)(a): securities premium may be used for fully paid bonus shares; Section 55(4): CRR may be used for fully paid bonus shares; Section 126: bonus shares kept in abeyance where a transfer is pending registration
Section 378ZJ separately lets a Producer Company issue bonus shares from general reserves.

How to solve Capitalisation of Profits and Bonus Shares questions

Use the same sequence for any theory or problem question on bonus shares. It follows the structure of the Act: provision, facts, conclusion.

  1. 1Identify the issue: can the company issue bonus shares, and from which reserve? Quote Section 63(1).
  2. 2Test the source. Is the reserve a free reserve, securities premium or CRR? If it arises from revaluation of assets, it is barred.
  3. 3Test the authority. Do the articles permit capitalisation? Has the Board recommended it and the general meeting authorised it?
  4. 4Test the defaults. Check fixed deposits, debt securities, and employees' dues such as PF, gratuity and bonus.
  5. 5Check partly paid shares. If any are outstanding on the date of allotment, they must first be made fully paid.
  6. 6Check Section 63(3): the issue must not be in lieu of dividend.
  7. 7For numbers, compute new shares from the ratio, multiply by face value, and pass the entry: debit the reserve, credit share capital.
  8. 8Conclude clearly: the company can or cannot issue, and state the reason with the section.

Quickest way: Source, authority, defaults, partly paid

When to use it: Use this for short case-based questions when you have about five minutes.

  1. Source: is it free reserves, securities premium or CRR? Revaluation reserve means stop.
  2. Authority: articles plus Board recommendation plus general meeting authorisation.
  3. Defaults: deposits, debt securities, and employees' PF, gratuity and bonus.
  4. Partly paid: make them fully paid first.
  5. Write the conclusion in one line with Section 63.

Common mistakes in Capitalisation of Profits and Bonus Shares

  • Treating revaluation reserve as a valid source of bonus shares.

    It appears on the balance sheet under reserves, so students assume it is free to use.

    Fix: Remember the proviso to Section 63(1): reserves created by revaluation of assets cannot be capitalised.

  • Saying only the Board decides to issue bonus shares.

    Students overlook that capitalisation needs members' approval.

    Fix: Write both: the articles must authorise, and the general meeting must authorise on the Board's recommendation.

  • Forgetting the condition on partly paid shares.

    Students list only the defaults and miss clause (e).

    Fix: Always add that outstanding partly paid shares must be made fully paid on or before the date of allotment.

  • Confusing bonus shares with dividend and saying bonus shares are paid in cash or reduce net worth.

    Both are called a reward to shareholders.

    Fix: Bonus shares are a capital conversion with no cash outflow. Net worth stays the same. Dividend is paid in cash. Section 63(3) bars bonus in lieu of dividend.

  • Debiting the wrong account in the journal entry.

    Students think a bonus issue is an expense or a cash receipt.

    Fix: Debit the reserve being capitalised (or securities premium or CRR). Credit equity share capital. No bank entry.

Worked examples

Example 1

Shine Textiles Ltd has 8,00,000 equity shares of ₹10 each, fully paid. It has a securities premium account of ₹20,00,000 and general reserve of ₹30,00,000. Its articles authorise capitalisation and the general meeting has approved a bonus issue of 1 share for every 4 held, using the general reserve. Pass the journal entry and state the effect on share capital.

Show the solution
  1. New shares = 8,00,000 × 1 ÷ 4 = 2,00,000 shares.
  2. Amount capitalised = 2,00,000 × ₹10 = ₹20,00,000.
  3. The general reserve is a free reserve, so it is a permitted source under Section 63(1)(i). The company needs only ensure no default and no partly paid shares.
  4. Entry: Debit General Reserve ₹20,00,000; Credit Equity Share Capital ₹20,00,000.
  5. General reserve falls from ₹30,00,000 to ₹10,00,000.
  6. Share capital rises from ₹80,00,000 to ₹1,00,00,000.

Answer: 2,00,000 bonus shares are issued. General Reserve A/c Dr. ₹20,00,000 to Equity Share Capital A/c ₹20,00,000. Share capital becomes ₹1,00,00,000 and the general reserve becomes ₹10,00,000.

Example 2

Ganga Pharma Ltd wants to issue bonus shares by capitalising its revaluation reserve of ₹15,00,000. Its articles permit capitalisation, and the general meeting has authorised it. The company has also defaulted on payment of interest on its fixed deposits. Advise the company.

Show the solution
  1. Provision: Section 63(1) permits bonus shares only out of free reserves, securities premium or CRR. Its proviso bars capitalising reserves created by revaluation of assets.
  2. Facts: the proposed source is a revaluation reserve of ₹15,00,000. This is a barred source.
  3. Section 63(2)(c) says no company shall capitalise unless it has not defaulted in payment of interest or principal on fixed deposits or debt securities. Ganga Pharma has defaulted on interest on fixed deposits.
  4. Authority under articles and general meeting is present, but this does not cure the source problem or the default.
  5. Both defects must be removed before any bonus issue.

Answer: Ganga Pharma cannot issue bonus shares as proposed. The revaluation reserve cannot be capitalised under the proviso to Section 63(1), and the default on fixed deposit interest violates Section 63(2)(c). It may issue only from a permitted source after curing the default.

Exam tips

  • Write the section number in the first line: Section 63 for bonus shares. Then give the provision, apply it to the facts and conclude.
  • List the three sources and the one barred source by name. Examiners look for revaluation reserve.
  • In case studies, scan facts for hidden traps: default on deposits, unpaid PF or gratuity, partly paid shares, or articles that are silent.
  • Add a link to Section 52(2)(a) for securities premium and Section 55(4) for CRR to show depth.
  • For journal entries, show the working of new shares and amount capitalised before the entry.

Practice questions from Distribution of Profits

Capitalisation of Profits and Bonus Shares in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capitalisation of Profits and Bonus Shares: frequently asked questions

What is the difference between bonus shares and dividend?

Dividend is a distribution of profits, normally paid in cash to registered shareholders. Bonus shares are fully paid shares issued by capitalising reserves, with no cash paid out. Section 63(3) says bonus shares cannot be issued in lieu of dividend.

Can bonus shares be issued out of revaluation reserve?

No. The proviso to Section 63(1) says no issue of bonus shares shall be made by capitalising reserves created by the revaluation of assets. Only free reserves, securities premium and capital redemption reserve are permitted.

What approvals are needed to issue bonus shares?

The articles must authorise capitalisation. The Board must recommend, and the general meeting must authorise the issue. The company must also meet the other conditions in Section 63(2), including no defaults and partly paid shares made fully paid.

Must bonus shares be fully paid-up?

Yes. Section 63(1) allows only fully paid-up bonus shares. Under Section 63(2)(e), any outstanding partly paid shares must be made fully paid on the date of allotment.