Stock dividends (also called bonus shares) represent the distribution of retained earnings to investors in the form of additional shares in the company instead of cash.

When companies have high retained earning but they do not have necessary excess cash, they resort to issuing stock dividends. Another motivation to issue stock dividends is to bring down the stock price in the market. Introduction of additional shares in the market without any increase in the company’s value reduces the company’s share price. Companies want to reduce their share price in order to bring down their price to earnings ratio and encourage investors to hold the company’s shares.

When the board of directors of a company declares a 10% stock dividend it means that additional shares equivalent to 10% of the current shares are to be issued to the shareholders. The accounting for stock dividend depends on whether it is considered to be a large stock dividend of a small one.

Small Stock Dividend

If the stock dividend is less than 20-25%, it is a small stock dividend and is accounted for by the journal entries explained below:

• At the time of declaration, retained earnings is debited by the amount equal to the product of the share’s market price, the stock dividend percentage and the current number of shares outstanding; and stock dividends distributable is credited by the same amount.
• At the time of issuance of 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 credit to additional paid-in capital.

Large Stock Dividend

If the stock dividend declared is more than 20%-25%, it is a large stock dividend and is more like a stock split. In this case, declaration is recorded by debiting retained earnings by the product of par value per share, percentage of stock dividend and number of outstanding shares; and crediting Stock Dividends Distributable. At the time of issuance, the stock dividends distributable are debited and common stock is credited.

Example

A company has 200,000 outstanding shares of common stock of $10 par value. It declares 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

Journal entry on the date of declaration:

Journal entry on the date of distribution:

The post Stock Dividends appeared first on Top Quality Courses.