7. Stock Dividends

Let's talk about stock dividends. Now, stock dividends stand in contrast to cash dividends. There are a couple reasons a company might choose a stock dividend over a cash dividend. First of all, they don't have to have the cash to pay if they're issuing stock. They might also want to lower the price of the stock, so that it becomes more attractive to a broader range of investors. Regardless of why a company would do it, let's talk about how they do it. When you have a stock dividend, it could be split into two different categories. You have small dividends and large dividends, and the line is kind of fuzzy.

Anything less than 20% to 25% is considered small, and anything greater than 20% to 25% is considered large. On your test, small is gonna be very clear. It's gonna be 5, 10%. Large is gonna be very clear. It's gonna be 30, 40, 50%. The point of these questions is not to see if you can figure out if 23% is small or large. That's just not the point, so don't spend any time worrying about that at all. Now, the only difference here, this is the one difference between small and large. When it's a small dividend, you record it at market value.

When it's a large dividend, you record it at par value. I'll explain why in a little bit, but first, let's work through some examples. Let's say that a shareholders' equity statement looks something like this. They've got common stock, $9 par, 25,000 issued and outstanding. On July 1, they declare and distribute a 5% stock dividend, and the market rate is $15 a share at that time. The first thing you wanna look out for here, like every dividend problem, is make sure you're issuing dividends on shares outstanding. Now, I told you issued and outstanding. Had I told you we have 30,000 issued and 5,000 treasury, you don't use this issued.

You have to use outstanding, which would come out to 25,000. Because of issued shares, some of them could be outstanding and some of them could be treasury. We don't pay dividends to ourselves, so you need to make sure that when you see a dividend problem, remind yourself, "I have to pay dividends on shares that are out in the wild, not shares that are sitting in the company's safe deposit box." So always keep your eyes open for that.

Next thing you wanna do is you wanna figure out, "How many shares am I actually giving out as a dividend?" I've got 25,000 outstanding, and I'm paying a 5% stock dividend. So you take your 25,000, multiply it by the 5% stock dividend, and you get 1,250 shares.

We're not done yet. You've gotten to shares, but we have to record things in dollar values, not share values. Since this is a small stock dividend, it's a 5% dividend, which is well below 20 to 25, we record it at market rate. Market rate is $15 per share, which gets us to 18,750. So our dividend is going to be 18,750. This is just like the cash dividend problems. You debit dividends for the amount. Not very complicated. Now, what we do here is we take common stock, and we put 1,250 shares in at the par value. So you can see that this is shaping up to be just like issuing stock.

So we put 1,250 times 9, or 11,250. That's our par value. Then we fill in the gap with the APIC, 7,500, and the APIC is also 1,250 times the $6 above par, gives us 7,500. If you'll remember that little illustration we've done, in this case, we've got $9 at par and $6 above par. So our APIC is 6 times the number of shares, and our par is 9 times the number of shares. Now, this is just like the entry we do when we issue stock, except instead of dividends, this would say cash. Hopefully, you can see that this is all kinda building upon itself.

When you have a small stock dividend, you use the market value of the shares. You first need to find out how many shares are you issuing. So you take the 25 outstanding, multiply it by the dividend percentage. That gives you the number of shares. Then you multiply that times the market rate, and that gives you the dollar value of your dividends. You put that into your dividends account, which is a debit account, and then you treat these as if it's just a stock issuance. You put your par in, then you put your APIC in. Not terribly difficult. I do wanna look at one kind of interesting thing.

Well, interesting to me. When you increase your dividends, you put 18,750 over here. What eventually happens? If you work it through, you're gonna close out your dividends, and that's gonna end up in retained earnings, right? So if you increase your dividends, you decrease your retained earnings, and if you decrease your retained earnings, you decrease your shareholders' equity. Because if you'll recall from one of the first chapters, shareholders' equity is retained earnings plus contributed capital. And we just recently learned you have to take out treasury stock, but we're not dealing with that right now. So if you decrease retained earnings, that flows up and decreases shareholders' equity.

So when you issue this dividend here, eventually you're decreasing shareholders' equity. Now, what about this? Contributed capital is also a part of shareholders' equity. So the dividend here decreases shareholders' equity, but this stock issuance bit, that increases shareholders' equity, doesn't it? That increases your contributed capital because contributed capital, if you'll recall, is preferred stock plus common stock plus all those APIC guys. So if you're increasing common stock and APIC, you're increasing contributed capital, which increases shareholders' equity.

So it turns out that this journal entry right here has no effect on shareholders' equity at all. Now, what it does do is it takes value out of retained earnings and transfers it to contributed capital. But since both of these live under shareholders' equity, that has no change whatsoever. So be prepared on the test when it says, "What effect does declaring and distributing a stock dividend have on shareholders' equity?" Well, on shareholders' equity, it has no effect. On retained earnings, it has an effect. On contributed capital, it has an effect. But on shareholders' equity, it has no effect at all. Keep your eyes open for that one.

Let's do a large stock distribution problem. We'll say the same thing, common stock, $9 par, 25,000 issued and outstanding. We declare a 50% stock dividend this time when the market rate is $15 per share. Because it's a 50% stock dividend, that is a very large stock dividend, which means we record it at par. And when I say we record it at par, we record the dividend at par. Up here, we recorded the dividend at the market value. This is what I'm talking about. Don't worry about this common stock and APIC down here. I'm talking about what do we record the dividend at?

And we decided we record the dividend at market rate for a small one. But for a large one, we have to record it at par value. So step one is still find the number of shares. 25,000 times 50% is 12,500 shares. Don't you dare stop there 'cause we have to find a dollar amount. Now, instead of using this 15, this is just here as a red herring. We need to use the $9 par, which gives us 112,500. So that is the value we put in for the dividend. Now, the next steps don't change at all.

Into the common stock account, we put the par value. It just so happens to be that the par value is the entire value in this case. So anything above and beyond par, we would put into APIC common stock, but there's nothing there, so we don't even record this at all. Because we recorded the dividend at par value, there's no room for APIC because the par value here eats up all of this here. And so since these match, we're done.

For the small one, this 18,750 was part par, part APIC, which is why we ended up splitting it out down here. For this 112,500, it's just par. There's no APIC aspect in this at all, so there's no APIC aspect in the journal entry at all. I told you I would give you a way to remember using some sort of logic that small uses market and large uses par.

Now, remember I told you that effectively what we're doing when we declare and distribute a stock dividend is we're taking retained earnings and we're moving that over to contributed capital because the dividend decreases the retained earnings and the issuance of the shares increases contributed capital. So we're recharacterizing retained earnings as contributed capital. We are capitalizing our retained earnings. This right here is how I remember that small uses market and large uses par. Let me show you.

Since we're recharacterizing retained earnings as contributed capital, you have to think that retained earnings is a finite account. There's not an infinite amount in retained earnings. And so what you really have to ask yourself is, how much can my retained earnings cover? If you have a small dividend, you have a relatively small percentage times a relatively large value, the market value. Since you have the small percentage, it's okay that you use the large value because odds are good your retained earnings are going to be able to cover that. If you have a large dividend, you have a relatively large percentage times a relatively small value, the par value.

It's okay that you use this large percentage because you're using this small dollar value, and odds are relatively good that you'll have enough in your retained earnings to recharacterize it as contributed capital. On the other hand, if you had a relatively large percentage times a relatively large dollar value, the market rate, odds are good that there wouldn't be enough in your retained earnings to recharacterize it as contributed capital. So we don't do that. We don't use the market rate when you have a large dividend. We use the par value. So on the test, if you freak out and forget, "I don't remember, large par, small market, or the other way around," try to remember if I use a large percentage and a large value, odds are good that I don't have enough retained earnings to cover that.

But if I use a large percentage and a small value, then odds are good that there's enough in retained earnings to cover it. Or you could remember small, big, big, small. You know, whatever works for you.