Stock Dividends Explained. Journal Entries

Summary

This session delves into the concept of stock dividends, explaining how they are derived from a company's retained earnings. It distinguishes between cash and stock dividends, highlighting the preservation of cash for internal growth or business operations. The session further clarifies the process of issuing stock dividends, detailing the accounting entries involved, and the impact on a company's equity structure. It also differentiates between small and large stock dividends, providing examples to illustrate the differences in accounting treatment. The instructor encourages students to visit farhatlectures.com for additional resources to enhance their CPA exam preparation.

Takeaways

• 📈 Dividends originate from a company's retained earnings, which is the profit left after expenses are deducted from revenues.
• 💰 Retained earnings are initially parked in an account and can later be paid out to shareholders as dividends.
• 🤑 Stock dividends are a way to reward shareholders without distributing cash, thus preserving the company's cash for internal growth or operations.
• 🔄 When issuing stock dividends, retained earnings decrease while common stock increases, with no overall effect on total equity.
• 📊 Stock dividends do not affect a company's assets, liabilities, or the total equity, but they do change the structure of equity.
• 👥 Shareholders receive new shares in proportion to their current ownership, maintaining their percentage of ownership in the company.
• 🏷 Two types of stock dividends are discussed: small stock dividends (less than 20-25% of outstanding shares) and large stock dividends (more than 20-25%).
• 📉 For small stock dividends, retained earnings are debited for the fair value of the shares issued, assuming minimal impact on stock price.
• 📈 In contrast, large stock dividends debit retained earnings for the par value of the shares issued, as the large number of new shares can affect the stock price.
• 📝 The script provides an example of how to account for stock dividends, illustrating the accounting entries for both small and large stock dividends.
• 📚 The speaker encourages accounting students and CPA candidates to use supplemental resources like their website for additional practice and lectures to succeed in their studies and exams.

Q & A

What is a stock dividend?

A stock dividend is a method of distributing a company's earnings to shareholders in the form of additional shares rather than cash. It is a way to reward shareholders while preserving the company's cash for other uses such as internal growth or operational needs.

What is retained earnings and why is it important in the context of dividends?

Retained earnings are the accumulated net income of a company that has not been distributed as dividends. It is important because it represents the profits that the company has reinvested or 'retained' for future use, which can then be distributed to shareholders in the form of dividends, including stock dividends.

How does a company decide whether to issue a cash dividend or a stock dividend?

A company decides to issue a cash dividend or a stock dividend based on its financial needs and strategic goals. If the company requires cash for investment in research and development, expansion, or operations, it may choose to issue a stock dividend to preserve cash.

What is common stock and how does it relate to stock dividends?

Common stock represents the ownership shares in a company held by the shareholders. In the context of stock dividends, the company issues new shares of common stock to shareholders, increasing their ownership proportion without affecting the company's assets, liabilities, or total equity.

How does issuing a stock dividend affect the company's financial statements?

Issuing a stock dividend reduces retained earnings and increases common stock on the company's balance sheet. However, it does not affect the company's total equity, assets, or liabilities, as it is an internal equity restructuring.

What is the difference between a small stock dividend and a large stock dividend?

A small stock dividend is when the company issues new shares that are less than 20 to 25 percent of the outstanding shares. A large stock dividend is when the percentage exceeds this threshold. The accounting treatment for each differs, especially in how retained earnings are debited.

How are stock dividends accounted for in the case of a small stock dividend?

For a small stock dividend, retained earnings are debited for the fair value of the shares issued, and common stock is credited for the par value of the new shares, with any difference being credited to additional paid-in capital.

What is the accounting treatment for a large stock dividend?

For a large stock dividend, retained earnings are debited for the number of shares issued times the par value of the stock. Common stock is credited for the same amount, and there is no additional paid-in capital involved since the shares are issued at par value.

How does a stock dividend affect the shareholder's ownership percentage in the company?

A stock dividend does not change the shareholder's ownership percentage in the company. They receive new shares in proportion to their current ownership, maintaining their relative equity stake.

What should a company consider when deciding the size of a stock dividend?

A company should consider the impact on the market value of its shares, the need to maintain a healthy balance sheet, and the potential effect on shareholders' perception when deciding the size of a stock dividend.

Why might a company issue a stock dividend instead of a cash dividend?

A company might issue a stock dividend instead of a cash dividend to preserve cash for internal growth, investment in new projects, or to maintain sufficient operational liquidity.