A stock dividend is a distribution of shares of a company’s stock to its shareholders. The number of shares distributed is usually proportional to the number of shares that each shareholder already owns. The treatment as a current liability is because these items represent a board-approved future outflow of cash, i.e. a future payment to shareholders. The carrying value of the account is set equal to the total dividend amount declared to shareholders. Once a proposed cash dividend is approved and declared by the board of directors, a corporation can distribute dividends to its shareholders. To record the payment of a dividend, you would need to debit the Dividends Payable account and credit the Cash account.
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The date of record determines which shareholders will receive the dividends. There is no journal entry recorded; the company creates a list of the stockholders that will receive dividends. Since there are 100,000 common shares outstanding, the total cash dividends will be $120,000. When a cash dividend is declared, the board of directors specifies an amount that is to be paid per share to stockholders as of specified record date on a specified payment date. In this case, the company will just directly debit the retained earnings account in the entry of the stock dividend declared.
A company may issue a dividend payment to shareholders made in shares rather than as cash. The stock dividend has the advantage of rewarding shareholders without reducing the company’s cash balance. Therefore, cash dividends reduce both the Retained Earnings and Cash account balances. Similar to the cash dividend, the company may not have the stock dividends account. This is usually due to it doesn’t want to bother keeping the general ledger of the current year dividends.
Journal Entries for Dividends (Declaration and Payment)
In this journal entry, as the company issues the small stock dividend (less than 20%-25%), the market price of $5 per share is used to assign the value to the dividend. Likewise, the common stock dividend distributable is $50,000 (500,000 x 10% x $1) as the common stock has a par value of $1 per share. At the date the board of directors declares dividends, the company can make journal entry by debiting dividends declared account and crediting dividends payable account. A traditional stock split occurs when a company’s board of directors issue new shares to existing shareholders in place of the old shares by increasing the number of shares and reducing the par value of each share. For example, in a 2-for-1 stock split, two shares of stock are distributed for each share held by a shareholder.
Recording Stock Transactions
A small stock dividend is viewed by investors as a distribution of the company’s earnings. Both small and large stock dividends cause an increase in common stock and a decrease to retained earnings. This is a method of capitalizing (increasing stock) a portion of the company’s earnings (retained earnings). A small stock dividend occurs when a stock dividend distribution is less than 25% of the total outstanding shares based on the shares outstanding prior to the dividend distribution. To illustrate, assume that Duratech Corporation has 60,000 shares of $0.50 par value common stock outstanding at the end of its second year of operations.
Part 2: Your Current Nest Egg
Duratech’s board of directors declares a 5% stock dividend on the last day of the year, and the market value of each share of stock on the same day was $9. Figure 14.9 shows the stockholders’ equity section of Duratech’s balance sheet just prior to the stock declaration. After the distribution, the total stockholders’ equity remains the same as it was prior to the distribution. The amounts within the accounts are merely shifted from the earned capital account (Retained Earnings) to the contributed capital accounts (Common Stock and Additional Paid-in Capital).
On the other hand, stock dividends distribute additional shares of stock, and because stock is part of equity and not an asset, stock dividends do not become liabilities when declared. Cash dividends are corporate earnings that companies pass along to their shareholders. First, there must be sufficient cash on hand to fulfill the dividend payment.
On the payment date, the following journal will be entered to record the payment to shareholders. On the date that the board of directors decides to pay a dividend, it will determine the amount to pay and the date on which payment will be made. In contrast, an established business might not need to retain profits and will distribute them as a dividend each year. The investors in such businesses are looking for a steady growth in the dividends. The subsequent distribution will reduce the Common Stock Dividends Distributable account with a debit and increase the Common Stock account with a credit for the $9,000.
From a practical perspective, shareholders return the old shares and receive two shares for each share they previously owned. The new shares have half the par value of the original shares, but now the shareholder owns twice as many. If a 5-for-1 split occurs, shareholders receive 5 new shares for each of the original shares they owned, and the new par value results in one-fifth of the original par value per share. The total stockholders’ equity on the company’s balance sheet before and after the split remain the same. A reverse stock split occurs when a company attempts to increase the market price per share by reducing the number of shares of stock. For example, a 1-for-3 stock split is called a reverse split since it reduces the number of shares of stock outstanding by two-thirds and triples the par or stated value per share.
Non-cash dividends, which are called property dividends, are more likely to occur in private corporations than in publicly held ones. When cash dividends are declared, if there is any preferred stock outstanding, the dividends have to be applied to the preferred stock first. We’ll tackle that in the next section after you check your understanding of accounting for cash dividends in general. When a dividend is declared by the board of directors, the company will credit dividends payable and debit an owner’s equity account called Dividends or perhaps Cash Dividends. These stock distributions are generally made as fractions paid per existing share. For example, a company might issue a 10% stock dividend, which would require it to issue 1 share for every 100 shares outstanding.
They are not considered expenses, and they are not reported on the income statement. They are a distribution of the net income of a company and are not a cost of business operations. For example, on December 18, 2020, the company ABC declares a 10% stock dividend on its 500,000 shares of common stock. Its common stock has a par value of $1 per share and a market price of $5 per share. The stock dividend is to distribute to the shareholders on January 12, 2021. On the payment date of dividends, the company needs to make the journal entry by debiting dividends payable account and crediting cash account.
Assuming there is no preferred stock issued, a business does not have to pay dividends, there is no liability until there are dividends declared. As soon as the dividend has been declared, the liability needs to be recorded in the books of account as dividends payable. A stock split is much like a large stock dividend in that both are large enough to cause a change in the market price of the stock.
- At the same time as the dividend is declared, the business will have decided on the date the dividend will be paid, the dividend payment date.
- Instead, the company prepares a memo entry in its journal that indicates the nature of the stock split and indicates the new par value.
- When a cash dividend is declared, the board of directors specifies an amount that is to be paid per share to stockholders as of specified record date on a specified payment date.
When the dividend is paid, the company’s obligation is extinguished, and the Cash account is decreased by the amount of the dividend. To see the effects on the balance sheet, it is helpful to compare the stockholders’ equity section of the balance sheet before and after the small stock dividend. Under current accounting practices, non-cash dividends are revalued to their current market value and a gain or loss is recognized on the disposition of the asset. To demonstrate the journal entries required when a cash dividend is declared and paid, let’s return to the above example. Because there must be a positive balance in retained earnings before a normal dividend can be issued, the phrase “paying dividends out of retained earnings” began to be commonly used. No dividends are paid on treasury stock, or the corporation would essentially be paying itself.
Many larger firms use a special checking account to disburse cash dividends. Again, in order to pay a cash dividend, a firm must have the necessary cash available, and the amount of cash on hand is not directly related to retained earnings. Cash Dividends is a contra stockholders’ equity account that temporarily substitutes for a debit to mytaxdoc accountant reviews the Retained Earnings account.
