Cash DividendsThe board of directors makes the decision to issue cash dividends, which entails more than just weighing the quantities of retained profits and cash. The board of directors, for example, may choose to keep the funds to invest in the corporation's development, handle crises, capitalize on unforeseen possibilities, or pay off debt. Alternatively, many corporations give monthly cash dividends to their stockholders. These cash flows provide a return to investors and usually always affect the market value of the stock.
Cash Dividend Accounting Dividend payment requires three key dates: proclamation, recording, and payment. The date of declaration is the day on which the board of directors’ votes to declare and pay a dividend. This makes the corporation legally liable to its investors. The date of record is the future date set by the board for identifying investors identified in the corporation's records who are eligible to receive dividends. The date of record is normally at least two weeks after the date of declaration. Dividends are paid to stockholders on the record date. The date of payment is the day on which the company makes payment; it is enough time after the date of record to allow the corporation to arrange cheques, money transfers, or other means of payment to pay dividends.
To illustrate, the entry to record a January 9 declaration of a $1 per share cash dividend by the directors of Z-Tech, Inc., with 5,000 outstanding shares is
- Date of Declaration
|5,000||Retained Earnings||Jan. 9|
|5,000||Common Dividend Payable|
|Declared $1 per common share cash dividend|
- Date of Payment
|5,000||Common Dividend Payable||Feb.1|
|Paid $1 per common share cash dividend|
Cash Dividends and Deficits A corporation with a negative (abnormal) balance for retained earnings has a retained earnings deficit, which occurs when a company incurs cumulative losses and/or pays more dividends than total earnings from current and preceding years. Exhibit 13.6 shows how a deficit is shown on the balance sheet as a deduction. Most jurisdictions make it illegal for a business with a deficit to issue a cash dividend to its owners. This legislative provision is intended to safeguard creditors by prohibiting the distribution of assets to stockholders while the company is in financial trouble.
|50,000||Common stock—$10 par value, 5,000 shares authorized, issued, and outstanding|
|(6,000)||Retained earnings deficit|
|44,000||Total stockholders’ equity|
A stock dividend declared by a corporation's board of directors is a distribution of extra shares of the corporation's own stock to its owners in exchange for no payment. Stock dividends and cash dividends are not the same thing. A stock dividend does not lower assets or equity; rather, it transfers equity from retained earnings to contributed capital.Reasons for Stock Dividends Dividends on stock exist for at least two reasons. First, directors are supposed to employ stock dividends to maintain the company's market price affordable. For example, if a company continues to produce money but does not pay out cash dividends, the value of its common stock will certainly rise. The price of such a stock may rise to the point that it discourages some investors from purchasing it (especially in lots of 100 and 1,000). A stock dividend increases the number of outstanding shares while decreasing the per share stock price. Another motivation for a stock dividend is to demonstrate management's belief that the firm is performing well and will continue to perform well.
Accounting for Stock Dividends A stock dividend affects the components of equity by transferring part of retained earnings to contributed capital accounts, capitalizing retained earnings is a term that is used sometimes. Accounting for a stock dividend differs depending on whether it is little or huge. A tiny stock dividend is defined as a payment of 25% or less of previously outstanding shares. It is calculated by capitalizing retained earnings for the market value of the shares to be distributed. A substantial stock dividend is one that distributes more than 25% of previously outstanding shares. A substantial stock dividend is calculated by capitalizing retained earnings for the minimum amount needed by the corporation's state legislation. Most states require capitalization retained earnings equal to the stock's par or declared value.To illustrate stock dividends, we use the equity section of Quest’s balance sheet shown in Exhibit 13.7 just before its declaration of a stock dividend on December 31.
|(before dividend) Stockholders’ Equity|
|100,000||Common stock—$10 par value, 15,000 shares authorized, 10,000 shares issued and outstanding|
|8,000||Paid-in capital in excess of par value, common stock|
|143,000||Total stockholders’ equity|
|15,000||Retained Earnings||Dec. 31|
| Common Stock Dividend Distributable|
Paid-In Capital in Excess of Par Value, Common Stock
|Declared a 1,000-share (10%) stock dividend.|
|(after dividend) Stockholders’ Equity|
|Common stock—$10 par value, 15,000 shares authorized, |
10,000 shares issued and outstanding
Common stock dividend distributable—1,000 shares
|13,000||Paid-in capital in excess of par value, common stock |
|143,000||Total stockholders’ equity|
- Date of Payment—Small Stock Dividend
|10,000||Common Stock Dividend Distributable||Jan. 20|
|10,000||Common Stock, $10 Par Value|
|o record issuance of common stock dividend.|
Recording a large stock dividend. A corporation capitalizes retained earnings up to the state law minimum for a substantial stock dividend. This number is the par or stated value of freshly issued shares in most states. As an example, assume Quest's board of directors declares a 30% stock dividend instead of a 10% dividend on December 31. Because this payout is greater than 25%, it is classified as a substantial stock dividend. As a result, the par value of the 3,000 dividend shares is capitalized with this entry on the day of declaration:
|30,000||Retained Earnings||Dec. 31|
|30,000||Common Stock Dividend Distributable|
|Declared a 3,000-share (30%) stock dividend|
A stock split is the distribution of extra shares to stockholders in proportion to their ownership percentage. When a stock split happens, the firm "calls in" its outstanding shares and issues multiple new shares for each old share. Splits are possible in any ratio, including 2-for-1, 3-for-1, and greater. Stock splits lower the stated or par value per share. Stock splits are motivated in the same way that stock dividends are.To illustrate, Comp Tec has 100,000 outstanding shares of $20 par value common stock with a current market value of $88 per share. A 2-for-1 stock split cuts par value in half as it replaces 100,000 shares of $20 par value stock with 200,000 shares of $10 par value stock. Market value is reduced from $88 per share to about $44 per share. The split does not affect any equity amounts reported on the balance sheet or any individual stockholder’s percent ownership. Both the Paid-In Capital and Retained Earnings accounts are unchanged by a split, and no journal entry is made. The only effect on the accounts is a change in the stock account description. Comp Tec’s 2-for-1 split on its $20 par value stock means that after the split, it changes its stock account title to Common Stock, $10 Par Value. This stock’s description on the balance sheet also changes to reflect the additional authorized, issued, and outstanding shares and the new par value.
The distinction between stock splits and huge stock dividends is frequently muddled. Many businesses declare stock splits in their financial accounts without calling in the original shares, just modifying their par value. This form of "split" is actually a substantial stock dividend, with more shares distributed to owners as a consequence of capitalization retained earnings or converting other paid-in capital to Common Stock. This method avoids the administrative expenditures of stock splitting. Harley-Davidson has announced a 2-for-1 stock split in the form of a 100% stock dividend.