The term stock dividend refers to the process of reclassifying retained earnings as contributed capital, and the issuing of stock instead of cash to shareholders. When a company pays a stock dividend, there is no distribution of assets. Instead, the total number of shares outstanding increases and the book value per share decreases.
The payment of dividends must be formally approved by the company's board of directors, even if the company has a long history of quarterly payments; the same is true whether the dividends are paid in cash or stock. In addition to board approval, companies are also required to have adequate earned capital before a stock dividend is declared.
When a company pays shareholders a stock dividend, it's classified as a non-reciprocal issuance on a pro-rata basis. This means each shareholder will own the same proportion of the corporation after the dividend is distributed. Stock dividends do not result in the distribution of retained earnings to shareholders. Instead, the total number of shares outstanding increases and retained earnings is reclassified as additional paid-in capital and common stock. Since the total number of shares outstanding will be higher after the dividend is distributed, the total book value per share is lower.
The accounting treatment for a stock dividend will depend on the number of shares distributed:
On January 15, Company A's board of directors approved a 5% stock dividend to holders of common stock to be paid on February 5 to shareholders of record on January 22. Company A currently has 10,000,000 shares of common stock outstanding and the market value on the date of declaration was $24.00 per share. Company A's common stock has a par value of $0.01 per share.
Since this is an ordinary (or small) stock dividend, a debit to retained earnings in the amount of 10,000,000 x 0.05 x $24.00, or $12,000,000 is made on the date of declaration:
|Retained Earnings: Declaration of Stock Dividend||$12,000,000|
|Stock Dividends Payable: 500,000 shares, par value $0.01||$5,000|
|Paid-in Capital in Excess of Par||$11,995,000|
On February 5, the following journal entry is made to reflect the distribution of the stock dividend to shareholders:
|Stock Dividends Payable||$5,000|