Instead of distributing cash dividends, companies can opt to issue stock dividends, which provide shareholders with additional shares of stock. This process represents a redistribution of equity rather than a cash payout. When a stock dividend is declared, it reduces retained earnings, similar to cash dividends, but instead of crediting cash, the company credits common stock and additional paid-in capital (APIC).
To calculate the stock dividend, the company uses the current market price of the stock, which is typically provided in the problem. Stock dividends are declared as a percentage of the outstanding common stock. For instance, a company might declare a 10% stock dividend on its existing shares. Small stock dividends, defined as those less than 20-25%, are the focus here.
For example, if a company has 150,000 shares of common stock outstanding with a par value of $0.50 and declares a 10% stock dividend, the calculation begins by determining the number of additional shares to be issued. This is done by multiplying the total outstanding shares by the dividend percentage:
\[150,000 \text{ shares} \times 0.10 = 15,000 \text{ shares}\]
Next, to find the total dollar amount of the stock dividend, the number of new shares is multiplied by the current market price of the stock, which is $25 in this case:
\[15,000 \text{ shares} \times 25 \text{ USD/share} = 375,000 \text{ USD}\]
The journal entry for this transaction involves reducing retained earnings by the total amount of the stock dividend, which is $375,000. The common stock account is credited with the par value of the new shares, calculated as:
\[15,000 \text{ shares} \times 0.50 \text{ USD/share} = 7,500 \text{ USD}\]
The remaining amount is credited to APIC, calculated as:
\[375,000 \text{ USD} - 7,500 \text{ USD} = 367,500 \text{ USD}\]
Thus, the journal entry reflects a decrease in retained earnings by $375,000, an increase in common stock by $7,500, and an increase in APIC by $367,500. This ensures that the accounting equation remains balanced, as the total equity remains unchanged, merely redistributed among the equity accounts.
In summary, stock dividends serve as a method for companies to reward shareholders without depleting cash reserves, while also maintaining the overall equity balance in the financial statements.
