Question

Douglas McDonald Company’s balance sheet included the following shareholders’ equity accounts at December 31, 2020: 

                                                                                           ($ in millions)

Paid-in capital: 

Common stock, 900 million shares at $1 par..................................$ 900 

Paid-in capital—excess of par.............................................................15,800 

Retained earnings....................................................................................14,888 

Total shareholders’ equity..................................................................$31,588 

On March 16, 2021, a 4% common stock dividend was declared and distributed. The market value of the common stock was $21 per share. Fractional share rights represented 2 million equivalent whole shares. Cash was paid in lieu of the fractional share rights. 

 

Required: 

1. What is a fractional share right? 

2. Prepare the appropriate entries for the declaration and distribution of the stock dividend.

Answer 1

Fractional Shares

When a company declares stock dividends or stock splits, the shareholders might receive share or fraction of full shares. Such shares are referred to as fractional shares.

 

1.

Fractional share right:

• The rights entitled by shareholders for the fractional shares they hold are referred to as fractional share rights.

• The fractional share rights entitle the shareholders the amount of cash for the fractional shares they hold.

• This cash payments made for the fractional shares by the company are referred to as ‘cash in lieu of fractional share rights’.

 

2.

Journalize stock dividend declaration and distribution transaction.

 

Accounting equation:

The following is the accounting equation to record the declaration of stock dividends:

                       Assets = Liabilities + Stockholders’ Equity 

-$42,000,000(Cash) = +{-$756,000,000(Retained Earnings)}

                     = + {+ $34,000,000(Common stock)}

                     = + {+ $680,000,000(Paid-in Capital in Excess of Par)}

 

Journal entry:

Record the following journal entry in the books of Company M:

Date	Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2016
March	16	Retained Earnings (E–)	756,000,000
		Common Stock (E+)		34,000,000
		Paid-in Capital in Excess of Par (E+)		680,000,000
		Cash (A–)		42,000,000
		(To record distribution of stock dividend)

 

Explanation:

• Retained Earnings is a stockholders’ equity account. The amount has deceased because stock dividends are distributed. Therefore, debit Retained Earnings account with $756,000,000.

• Common Stock is a stockholders’ equity account and the amount has increased due to the distribution of stock dividends. Therefore, credit Common Stock account with $34,000,000.

• Paid-in Capital in Excess of Par is a stockholders’ equity account and the amount has increased due to increase in capital excess of common stock value. Therefore, credit Paid-in Capital in Excess of Par account with $680,000,000.

• Cash is an asset account. The amount has reduced because cash is paid in lieu of fractional share rights. Therefore, credit Cash account with $42,000,000.

 

Working Notes:

Compute stock dividends amount.

Stock  dividends shares = Number of shares outstanding × Stock dividend percentage

                                           = 900,000,000 shares × 4/100

                                           = 36,000,000 shares ……. (1)

 

Stock dividends = Stock dividend shares × Market value per share

                             = 36,000,000 shares × $21

                             = $756,000,000

 

Note: Refer to Equation (1) for value and computation of stock dividend shares.

 

Compute common stock value.

Common stock value = [(Stock dividend shares – Fractional share right shares) × Par value of stock]

                                       = (36,000,000 shares – 2,000,000 shares) × $1

                                       = $34,000,000

 

Note: Refer to Equation (1) for value and computation of stock dividend shares.

 

Compute excess of par value of shares.

Excess of par value = Market price – Par value

                                   = $21 - $1

                                   = $20 ……………. (2)

 

Compute paid-in capital in excess value.

Paid-in capital in excess value = [(Stock dividend shares – Fractional shares) × Excess of par value]

                                                      = (36,000,000 shares – 2,000,000 shares) × $20

                                                      = $680,000,000

 

Note: Refer to Equations (1) and (2) for value and computation of stock dividend shares and excess of par value of share.

 

Compute cash paid by company in lieu of fractional shares.

Cash paid = Number of fractional shares × Market price

                  = 2,000,000 shares × $21

                  = $42,000,000

Paid-in capital in excess value = $680,000,000 

Cash paid = $42,000,000