Question

Smoky Joe's, Inc., a rapidly growing chain of BBQ restaurants, has had considerable increases in the value of their common stock over the years. Normally, the Board of Directors declares a modest cash dividend. But this year, they decided to issue a 50% stock dividend. Your friend, a new investor that saw potential in the company early on, came to you excited about the news, saying that he is getting free stock and that this is much better than the cash dividends from last year. Using what you have learned in accounting thus far, respond to your friend's statement including the following points:

1. What does a 50% stock dividend really mean?
2. Is your friend really getting "free stock"?
3. Which would you prefer, a cash dividend or a stock dividend?

Please include references.

Answer 1

With 50% stock dividend the investor receives additional 50% shares. He does not receive any cash. 50% stock dividend means the stockholder will receive additional one share for every two shares held. .

Since every shareholder receives additional shares, the total number of outstanding shares goes up, without change in equity value. Hence book value per share is reduced. Total market value also remains same and market value per share is reduced Because there are 50% more shares outstanding, each share drops in value. With each stockholder receiving 50% of additional shares and the market value of each share decreasing in value, each stockholder should end up with the same total market value as before the stock dividend.

The journal entry in the books of the company, for stock dividend will be :

Debit ….Retained Earnings

Credit….Common stock

Amount is transferred from retained earnings to commonstock.

By the amount of par value of number of additional shares issued.

In the case of cash dividend, the investor receives cash in hand. Though the market value of his total holdings is likely to decrease.

Assume an investor is holding 100 shares with par value $1 per share.

In case of cash dividend of 50%, he would receive $50 in hand.

In case of stock dividend of 50% he would receive 50numbers of additional shares .

Investors looking for regular income will prefer cash dividend. Investors who do not want regular income will prefer stock dividend because no tax is required to be paid for stock dividend. Cash dividend will attract tax.