Meaning: - A company following conservative dividend policy accordingly shall transfer a large portion of divisible profits to the reserves every year. The accumulation of such retained may enable the company to capitalise its profits so as to establish proper balance between the paid-up capital and reserves. However, the capitalisation of profits is termed as issue of bonus shares.

Bonus shares can be defined as shares issued by the company to its existing equity shareholders out of accumulated reserves. The bonus shares are equity shares that are issued to existing equity shareholders free of cost or as a gift by the company.
Conditions for issue of Bonus Shares

1.       The issue of bonus shares must be authorized by Articles of Association of the company. If it is not provided, the company should pass a resolution in its shareholders meeting making provision in the Articles for issuing bonus shares.
2.       It must be recommended by a board resolution and then approved by the shareholders in general meeting.
3.       The bonus issue is made out of free reserves built out of genuine profits or share premium collected in cash.
4.       Reserves created by revaluation of fixed assets are not capitalised for bonus shares.
5.       The bonus issue is not made unless the partly paid-up shares, if any existing is made fully paid-up.
6.       There can be issue of bonus shares only twice in a period of 5 years.
7.       The company issuing bonus shares should not have defaulted in payment of statutory dues such as contribution to provident fund, gratuity, and bonus.
8.       Consequent to the issue of Bonus Shares, if the subscribed and paid-up capitals exceed the authorized capital, a resolution should be passed by the company at its general body meeting for increasing the authorized capital.
9.       No bonus shares issue can be made by the company which will dilute (reduce in strength) the value or rights of the share holders of convertible debentures, fully or partly.

10.    Bonus shares cannot be issued within 12 months of any public right issue or right issue.