Share premium account can be used to issue bonus shares or script dividends.
Payment of script dividends does not involve cash outflow.
Accounting effect of script dividend is the transfer of balance from share premium account to share capital account. Therefore, it result no change in overall equity.
Share Premium Account DR
Share Capital Account CR
(To record the script dividend)
However, script dividend results in greater number of ordinary shares than before.
1.1 Benefits of Script Dividend
Script dividend allows entity to retain cash for investing activities, while providing dividends to shareholders. Shareholders may sell bonus share allotted as a result of script dividend to realise cash.
It increases the marketability of shares as market price per share after script dividend falls, which allows even smaller investors to buy shares in the company.
Script dividend is useful when entity is facing liquidity problems.
Script dividend increases number of shares in issue, which can provide appearance of large entity, than if large share premium reserve is kept. However, there is no real improvement in financial position of the entity. The effect is merely psychological.
Script dividend may be more acceptable to high rate taxpayer to defer tax liability on dividend payment. Capital gains tax is only payable when bonus shares are sold, which may attract capital gains tax relief up to certain amount.
1.2 Disadvantages of Script Dividend
Script dividend may not be acceptable to low rate taxpayer. Script dividend can expose them to capital gains tax having higher rate than income tax rate applicable.
Shareholders may perceive script dividend as liquidity (cash flow) problem in the organization.
Decrease in share price may result in loss of esteem value, which is associated with high value shares. It may decrease attractiveness of shares to existing investors and may sell their shares to new shareholders.
Script dividend may result in dilution of control, if existing shareholders sell their bonus shares to new shareholders to get dividend.