Principles of Financial Accounting: Stockholders' Equity - Stock Dividends, Small vs. Large Effects on Retained Earnings Share Price

What It Is

A stock dividend is a distribution of additional shares of stock to existing shareholders, rather than cash. This is done to conserve cash and maintain a stable share price. For example, if a company has 100,000 shares outstanding and declares a 10% stock dividend, each shareholder will receive 10,000 additional shares. This increases the total number of shares outstanding to 110,000.

Key Concepts & Formulas

• Retained Earnings: The portion of net income that is reinvested in the business, rather than distributed to shareholders. Retained Earnings = Net Income - Dividends. If a company has $100,000 in net income and declares a $20,000 cash dividend, its retained earnings will be $80,000.
• Stock Dividend Ratio: The percentage of shares distributed to shareholders. If a company declares a 10% stock dividend, it will distribute 10% of the total number of shares outstanding.
• Par Value: The minimum value assigned to each share of stock. If a company has a par value of $1 per share and declares a 10% stock dividend, the total par value of the additional shares will be $10,000 (10% of 100,000 shares).
• Book Value per Share: The total book value of the company divided by the total number of shares outstanding. If a company has a book value of $500,000 and 100,000 shares outstanding, its book value per share is $5.
• Market Value per Share: The current market price of the company's stock. If a company's market value per share is $50 and it declares a 10% stock dividend, the market value per share will decrease to $45.50.
• Number of Shares Outstanding: The total number of shares of stock issued by the company. If a company has 100,000 shares outstanding and declares a 10% stock dividend, the total number of shares outstanding will increase to 110,000.
• Total Par Value: The total value of all shares of stock issued by the company. If a company has a par value of $1 per share and 100,000 shares outstanding, its total par value is $100,000.

Journal Entry Examples

1. Dr. Retained Earnings $80,000 Cr. Common Stock $80,000 Cr. Dividends Payable $20,000 This journal entry records the declaration of a $20,000 cash dividend and the corresponding decrease in retained earnings.

2. Dr. Retained Earnings $0 Cr. Common Stock $10,000 This journal entry records the declaration of a 10% stock dividend, which increases the total par value of the company's stock.

Common Mistakes

• Mistake: Confusing debits and credits for expense accounts.
• Correction: Remember that debits increase assets and expenses, while credits increase liabilities and equity.
• Mistake: Not considering the impact of a stock dividend on the company's financial statements.
• Correction: A stock dividend increases the total number of shares outstanding, which can affect the company's earnings per share and book value per share.
• Mistake: Assuming that a stock dividend is the same as a cash dividend.
• Correction: A stock dividend is a distribution of additional shares of stock, while a cash dividend is a distribution of cash to shareholders.

Exam Tips

• Tip: Remember that a stock dividend increases the total number of shares outstanding, which can affect the company's earnings per share and book value per share.
• Tip: Be careful when calculating the total par value of the company's stock, as it is affected by the par value per share and the total number of shares outstanding.
• Tip: A stock dividend is not an expense, but rather a distribution of additional shares of stock.

Quick Practice

1. A company has 100,000 shares outstanding and declares a 10% stock dividend. What is the total number of shares outstanding after the dividend is declared? Answer: 110,000 Explanation: The total number of shares outstanding increases by 10% of the original number of shares.

2. A company has a book value of $500,000 and 100,000 shares outstanding. If it declares a 10% stock dividend, what is the new book value per share? Answer: $4.55 Explanation: The book value per share decreases as the total number of shares outstanding increases.

3. A company has a par value of $1 per share and 100,000 shares outstanding. If it declares a 10% stock dividend, what is the total par value of the additional shares? Answer: $10,000 Explanation: The total par value of the additional shares is 10% of the original total par value.

Last-Minute Cram Sheet

1. Retained Earnings = Net Income - Dividends
2. Stock Dividend Ratio = (Number of Additional Shares / Total Number of Shares Outstanding) x 100
3. Par Value = Minimum value assigned to each share of stock
4. Book Value per Share = Total Book Value / Total Number of Shares Outstanding
5. Market Value per Share = Current market price of the company's stock
6. Number of Shares Outstanding = Total number of shares of stock issued by the company
7. Total Par Value = Total value of all shares of stock issued by the company
8. Dividends are NOT an expense – they go directly to retained earnings
9. A stock dividend increases the total number of shares outstanding
10. The book value per share decreases as the total number of shares outstanding increases