Question

CASE 15‐9 Stock Dividends

The directors of Lenox Corporation are considering issuing a stock dividend.

Required:

1. What is a stock dividend? How is a stock dividend distinguished from a stock split from a legal standpoint? From an accounting standpoint?
2. For what reasons does a corporation usually declare a stock dividend? A stock split?
3. Discuss the amount, if any, of retained earnings to be capitalized in connection with a stock dividend.

Answer 1

Stock dividend is a form of dividend payment where the companies return a profit to their investors by giving them additional shares of the company instead of a cash dividend. This makes them own a higher number of shares in that company.

The decision of issuing this dividend is done by the board of directors of that company. Many times, the decision of paying these dividends is inspired by the need of keeping shareholders encouraged with their investment without paying out any actual cash. This way, the investors get a healthy return on their investments and the company also doesn’t have to part away with any capital.

Head to Head Comparison between Stock Dividend vs Stock Split(Infographics)
Below is the top differences between Stock Dividend vs Stock Split

A stock dividend means dividend which is paid in the form of additional shares whereas stock split is a division of issues shares in the ratio as decided by Company.
In the Stock dividend, additional shares are given to shareholders whereas in stock split already issued shares are split in an agreed ratio. No additional shares are allotted
The main reason for the stock dividend is due to the shortage of cash flow in the company whereas the main purpose for the stock split is for reducing the market price of the shares
There is a Journal Entry passed for Stock Dividend i.e debiting the Reserves (Retained Earnings) and crediting the Issued Share Capital, whereas no Journal Entry is passed in case of Stock Split only the details are mentioned in issued share capital.
In a stock dividend, existing shareholders are allotted additional shares whereas the shares which are already held are divided.

Stock Dividend vs Stock Split are both Corporate Action terms. Both have similarities but these are not similar. The Purpose of both Stock Dividend vs Stock Splits are totally different from each other. Whenever these terms are used, one should not treat them as the same should be careful.

A corporation might declare a stock dividend instead of a cash dividend in order to 1) increase the number of shares of stock outstanding, 2) move some of its retained earnings to paid-in capital, and 3) minimize distributing the corporation's cash to its stockholders.

If a corporation has 100,000 shares of stock outstanding and it declares a 10% stock dividend, the corporation ends up having 110,000 shares outstanding. An individual stockholder having 1,000 shares prior to the 10% stock dividend will have 1,100 shares after the stock dividend. This individual's stake in the corporation was 1% (1,000 out of 100,000 shares) prior to the stock dividend and will remain at 1% (1,100 out of 110,000 shares) after the stock dividend.

Stock dividend declarations and it's reasons:

Since the corporation hasn't really changed because of the stock dividend, the total market value of the corporation should not change. In other words, if the total market value of the corporation was $1 million before the stock dividend, it should be $1 million after the stock dividend. However, the market value of each share should decrease: $1,000,000 divided by 100,000 shares = $10 per share, and $1,000,000 divided by 110,000 shares = $9.0909. The total market value of the individual's holdings should also remain the same: 1,000 shares X $10 = $10,000, and 1,100 shares X $9.0909 = $10,000. If the market does not adjust for the increased number of shares, the individual stockholders will benefit.

Reasons for a stock spilt:

A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares.
Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split does not add any real value.
The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.
Reverse stock splits are the opposite transaction, where a company divides, instead of multiplies, the number of shares that stockholders own, raising the market price accordingly.

Corporations usually account for stock dividends by transferring a sum from retained earnings to permanent paid-in capital. The amount transferred for stock dividends depends on the size of the stock dividend. For stock dividends, most states permit corporations to debit Retained Earnings or any paid-in capital accounts other than those representing legal capital. In most circumstances, however, they debit Retained Earnings when a stock dividend is declared.

Stock dividends have no effect on the total amount of stockholders’ equity or on net assets. They merely decrease retained earnings and increase paid-in capital by an equal amount. Immediately after the distribution of a stock dividend, each share of similar stock has a lower book value per share. This decrease occurs because more shares are outstanding with no increase in total stockholders’ equity.