Stock Dividends

Stock dividends (also called bonus shares) refer to issuance of shares of common stock by a company to its existing shareholders in the proportion of their shareholding without any receipt of cash.

Companies use stock dividends to convert their retained earnings to contributed capital. They are ‘dividends’ in the sense that they represent distribution to shareholders. However, they are not ‘dividends’ in the traditional sense because they do not represent any transfer of value to shareholders because the market price of the stock drops proportionately after the issuance of stock dividends. Companies issue stock dividends when they want to bring down the market price of their common stock.

Accounting for a stock dividend

As a stock dividend represents an increase in common stock without any receipt of cash, it is recognized by debiting retained earnings and crediting common stock. The amount at which retained earnings is debited depends on the level of stock dividend, i.e. whether is a small stock dividend or a large stock dividend.

Small stock dividend

A stock dividend is small if it is less than 20-25% of the existing shares of common stock. In case of a small stock dividend, the accounting treatment is just like a regular cash dividend. It involves the following journal entries:

  • At the time of declaration, retained earnings are debited by an amount equal to the product of the share's market price, the stock dividend percentage and the current number of common shares outstanding; and stock dividends distributable account is credited by the same amount.
  • At the time of issuance of the stock, the stock dividends distributable is debited by the full amount, common stock is credited by amount equal to the product of par value per share, stock dividend percentage and the number of current shares outstanding. Any excess of stock dividends distributable over the amount credited to common stock is credited to additional paid-in capital.

Large stock dividend

If the stock dividend declared is more than 20%-25% of the existing common stock, it is considered a large stock dividend and its accounting treatment is more like a stock split. In this case, at the declaration date, retained earnings are debited by the product of par value per share, percentage of stock dividend and number of outstanding shares; and common stock dividends distributable is credited. At the time of issuance, the stock dividends distributable are debited and common stock is credited. Large stock dividends do not result in any credit to additional paid-up capital.

Example

A company has 200,000 outstanding shares of common stock of $10 par value. It declares a 10% stock dividend. The market price per share of common stock was $15 on the date of declaration.

Record the declaration and payment of the stock dividend using journal entries.

Solution

As the company has declared a 10% stock dividend, it would be accounted just like a cash dividend.

Journal entry on the date of declaration:

Retained Earnings300,000
Stock Dividends Distributable300,000

Journal entry on the date of distribution:

Stock Dividends Distributable300,000
Common Stock200,000
Addition Paid-In Capital100,000

by Obaidullah Jan, ACA, CFA and last modified on
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