A company that lacks sufficient cash for a cash dividend may declare a stock dividend to satisfy its shareholders. Note that in the long run it may be more beneficial to the company and the shareholders to reinvest the capital in the business rather than paying a cash dividend. If so, the company would be more profitable and the shareholders would be rewarded with a higher stock price in the future.

Stock dividends are payable in additional shares of the declaring corporation’s capital stock. When declaring stock dividends, companies issue additional shares of the same class of stock as that held by the stockholders.

Corporations usually account for stock dividends by transferring a sum from retained earnings to permanent paid-in capital. The amount transferred for stock dividends depends on the size of the stock dividend. For stock dividends, most states permit corporations to debit Retained Earnings or any paid-in capital accounts other than those representing legal capital. In most circumstances, however, they debit Retained Earnings when a stock dividend is declared.

Stock dividends have no effect on the total amount of stockholders’ equity or on net assets. They merely decrease retained earnings and increase paid-in capital by an equal amount. Immediately after the distribution of a stock dividend, each share of similar stock has a lower book value per share. This decrease occurs because more shares are outstanding with no increase in total stockholders’ equity.

Stock dividends do not affect the individual stockholder’s percentage of ownership in the corporation. For example, a stockholder who owns 1,000 shares in a corporation having 100,000 shares of stock outstanding, owns 1% of the outstanding shares. After a 10% stock dividend, the stockholder still owns 1% of the outstanding shares—1,100 of the 110,000 outstanding shares.

A corporation might declare a stock dividend for several reasons:

• Retained earnings may have become large relative to total stockholders’ equity, so the corporation may desire a larger permanent capitalization.
• The market price of the stock may have risen above a desirable trading range. A stock dividend generally reduces the per share market value of the company’s stock.
• The board of directors of a corporation may wish to have more stockholders (who might then buy its products) and eventually increase their number by increasing the number of shares outstanding. Some of the stockholders receiving the stock dividend are likely to sell the shares to other persons.
• Stock dividends may silence stockholders’ demands for cash dividends from a corporation that does not have sufficient cash to pay cash dividends.

The percentage of shares issued determines whether a stock dividend is a small stock dividend or a large stock dividend. Firms use different accounting treatments for each category.

Recording small stock dividends A stock dividend of less than 20 to 25% of the outstanding shares is a small stock dividend and has little effect on the market value (quoted market price) of the shares. Thus, the firm accounts for the dividend at the current market value of the outstanding shares.

Assume a corporation is authorized to issue 20,000 shares of  $100 par value common stock, of which 8,000 shares are outstanding. Its board of directors declares a 10% stock dividend (800 shares). The quoted market price of the stock is $125 per share immediately before the stock dividend is announced. Since the distribution is less than 20 to 25 per cent of the outstanding shares, the dividend is accounted for at market value. The entry for the declaration of the stock dividend on August 10, is:

This entry records the issuance of the shares:

The common stock dividend distributable account is a stockholders’ equity (paid-in capital) account credited for the par or stated value of the shares distributable when recording the declaration of a stock dividend until the stock is issued to shareholders. Since a stock dividend distributable is not to be paid with assets, it is not a liability.

Suppose, on the other hand, that the common stock in the preceding example is no-par stock and has a stated value of  $50 per share. The entry to record the declaration of the stock dividend (when the market value is  $125) is:

Stock Splits

A company can control their market price in some cases.  When the market price is too high, people will not invest in the company.  What can we do?  We can split our stock!  A stock splits does not cause an accounting entry as it does not change any monetary amounts listed on the financial statements.  What does it do?

• Shares increase by number of the stock split
• Par value decreases by the number of the stock split

As an example, think of a pizza.  The pizza has 8 slices and costs $16 per pizza which is $2 per share ($16 price / 8 slices).   I ask the pizza parlor to double-cut the pizza into 16 slices instead of 8 slices.  The cost of my pizza is still $16 but the cost per slice is now $1 per slice ($16 cost / 16 slices).

The 8 slices of a typical pizza represent the shares of stock and the $2 cost per share is the par value of the stock.  When I double cut the pizza, this represents a 2-1 stock split with 16 shares of stock (or slices of pizza) for the new par value of $1 per share.

Accounting in the Headlines

How did Apple’s 7-for-1 stock split affect its total stockholders’ equity?

In June 2014, Apple, Inc. (AAPL) did a 7-for-1 stock split, meaning that an investor who previously held one share of Apple stock would have seven shares on the date of the split.  Before the split, Apple had 861 million shares of stock valued at roughly $650 each.  After the split, Apple had approximately 6 billion shares valued at roughly $94 per share.  (The total market value of Apple’s stock increased on the date of the stock split due to market fluctuation; the stock split had no immediate impact on the value of Apple.)