Accounting for a small stock dividend
/What is a Stock Dividend?
A stock dividend is the issuance by a corporation of its common stock to its common shareholders without any consideration. A dividend of this type is usually issued when a business does not have sufficient cash to spare for a normal dividend, but still wants to give the appearance of issuing a payment to its shareholders. This can happen when there is pressure from shareholders to issue a dividend.
Small Stock Dividends vs. Stock Splits
A small stock dividend involves issuing additional shares to existing shareholders, typically amounting to less than 20% to 25% of the company's previously outstanding shares. It is treated as a reallocation of retained earnings to common stock and additional paid-in capital, and it slightly dilutes the share price without changing the overall value of each shareholder’s investment. In contrast, a stock split increases the number of shares outstanding by a larger proportion, such as 2-for-1 or 3-for-1, without affecting the company's overall equity accounts. A stock split simply reduces the par value per share and the market price per share proportionally, making the stock more affordable without altering the total value of each shareholder’s holdings. In essence, a small stock dividend is an equity distribution recorded in the financial statements, while a stock split is mainly an administrative adjustment to share structure.
How to Account for a Small Stock Dividend
When there is a stock dividend, you should transfer from retained earnings to the capital stock and additional paid-in capital accounts an amount equal to the fair value of the additional shares issued. The fair value of the additional shares issued is based on their market value after the dividend is declared. One effect of this transaction is that the amount of legal capital (the capital stock account) is increased by the par value of the additional shares issued; this amount can no longer be issued to shareholders as a dividend.
A stock dividend is never treated as a liability, since it does not reduce assets.
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Example of a Small Stock Dividend
Frederick Engineering declares a stock dividend to its shareholders of 10,000 shares. The fair value of the stock is $5.00, and its par value is $1.00. Frederick records the following journal entry:
