FinancialManagementPro.com

Stock Dividends

By Yuriy Smirnov Ph.D.

Definition

Stock dividends payout does not cause a cash outflow. It is the distribution of additional shares among current stockholders. This may happen when management of a corporation does not intend to spend cash for dividend payout but wants to give something to investors. For example, if the board of directors approves 20% in stock dividends, each current stockholder will receive an additional 2 shares for every 10 shares they have.

Such a decision will have the following outcomes:

  1. The value of the corporation remains constant, but the stock price declines in proportion to the number of shares outstanding.
  2. All stockholders receive additional shares in proportion to their current holdings; therefore, the proportion of each of them remains constant.
  3. Stock dividends cause a decline in earnings per share (EPS) and dividends per share (DPS).

How stock dividends affect the stock price

Payout of stock dividends does not increase the value of the corporation, so the stock price should decline. However, a number of empirical studies have shown that investors consider them a positive signal indicating that corporate management is expecting an increase in future earnings. Therefore, the stock price is often increasing after the declaration date. If a corporation fails to generate bigger earnings in the near future, the stock price will fall.

Journal entries

Although total equity remains unchanged, stock dividends affect stockholders’ equity and retained earnings. Please note that journal entries to be made also depend on the number of new shares being issued.

Small stock dividends

If the new stock being issued is below 20%–25% of the stock outstanding before the payment date, it is considered small. The following journal entries are required to be made on the declaration date:

Small stock dividends journal entry

The journal entries to be made on the payment date are as follows:

Small stock dividends journal entry

Large stock dividends

If the new stock being issued exceeds 20%–25% of the stock outstanding before the payment date, it is considered large. We should make the following journal entries on the declaration date:

Large stock dividends journal entry

The journal entries to be made on the payment date are as follows:

Large stock dividends journal entry

Example

Example 1

On 06/03/20X8, the board of directors announced that 10% in stock dividends would be paid on 08/01/20X8. On the declaration date (06/03/20X8), the number of shares of common stock outstanding was 50,000. The par value of a share is $10.

The number of shares of new stock being issued and distributed among stockholders is 5,000. Let’s assume that the stock price on the declaration date was $17. As the number of shares of new stock is small (below 20%–25%), we should make following journal entries:

Small stock dividends journal entry example

Market value of new stock = 5,000 × $17 = $85,000

Par value of new stock = 5,000 × $10 = $50,000

Value in excess of par = $85,000 - $50,000 = $35,000

The balance of the “Retained Earnings” account decreases by the market value of new stock of $85,000, the balance of the “Stock Dividends Distributable” account increases by the par value of new stock of $50,000, and the “Paid-in Capital in Excess of Par” account increases in value in excess of par by $35,000.

The journal entry to be made on the payment date (08/01/20X8) is as follows:

Small stock dividends journal entry example

Example 2

Let’s suppose the board of directors declared 40% in stock dividends on 12/10/20X8. The par value of the stock is $20, and the number of shares of common stock outstanding on the declaration date is 30,000. Thus, 12,000 (30,000 × 40%) shares of new stock should be distributed among stockholders on the payment date 01/14/20X9.

Since we have a large amount of stock dividends, the journal entry to be made on the declaration date is as follows:

Large stock dividends journal entry example

Par value of new stock = 12,000 × $20 = $240,000

The balance of the “Retained Earnings” account decreases by the par value of new stock, and the balance of the “Stock Dividends Distributable” account increases by the same amount.

On the payment date, the “Stock Dividends Distributable” account decreases by $240,000, and the “Common Stock” account increases by the same amount.

Large stock dividends journal entry example