Do Stock Dividends Affect the Retained Earnings Account?
Companies usually distribute dividends to their shareholders in cash, but they sometimes give them stock instead. Dividends of any kind, cash or stock, represent a return of profits to the company owners, so they reduce the retained earnings account in the stockholders' equity section of the balance sheet. After all, retained earnings is simply the company's accumulated profits.
Accounting for a Cash Dividend
To understand the accounting for a stock dividend, it helps to take a quick look at how a cash dividend affects the balance sheet. Say your company declares that it will pay a cash dividend to its shareholders totaling $100,000. (How that breaks down per share is irrelevant to the accounting.) The company reduces its retained earnings balance by $100,000. On the asset side, the company reduces its cash balance by $100,000, reflecting the actual payment. The balance sheet remains balanced. Your company is now worth $100,000 "less" because it returned that money to the shareholders.
Small vs. Large Dividends
A stock dividend, by definition, doesn't involve cash, so it has no effect on the cash account. In fact, a stock dividend doesn't affect assets at all, because while the company gives out more stock, the overall value of the company doesn't change. The accounting occurs entirely in the equity section of the balance sheet. Accounting rules recognize two kinds of stock dividends: large and small. A "large" stock dividend is any distribution that would send enough new stock into circulation that it would significantly reduce the share price. The general rule of thumb defines a large stock dividend as one that increases the number of outstanding shares by 20 percent to 25 percent. Anything that isn't a large dividend is a small one.
Large Stock Dividends
In a large stock dividend, the company determines the total value of the dividend by multiplying the number of new shares to be distributed by the par value of the stock. A stock's par value is a nominal face value -- often a penny or less per share -- that's required by law in many states. Say your company has $10,000 shares outstanding with a par value of 5 cents per share and plans to distribute 7,000 new shares. The dividend is a large one, with a total value of $350. The company reduces the retained earnings account by $350 and increases the common stock account, also in the equity section, by $350. The balance sheet stays in balance.
Small Stock Dividends
With a small stock dividend, the company determines the total value of the dividend by multiplying the number of new shares to be distributed by the current market price of the shares -- not the par value. Say your company has 10,000 shares outstanding with a par value of 5 cents and will distribute 1,000 new shares at the market price of $15 a share. The dividend is a small one with a value of $15,000. The company reduces the retained earnings account by $15,000 and increases the common stock account by $15,000. The balance sheet stays balanced.
- AccountingCoach: Stock Splits and Stock Dividends
- Financial Accounting for MBAs, Fourth Edition; Peter Easton, et al
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.