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What is a Stock Dividend?
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 stock dividend is done by the board of directors of that company. Many times, the decision of paying stock 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.
Stock Dividend Example
In general, These are mostly issued on basis of percentage of existing holdings of stocks. For instance, let us assume that a company XYZ has announced to issue stock dividends of 30 percent. What this implies is that each and every shareholder of that company will see their stock holdings go up by 30 percent. So, if person A earlier had 100 shares of company XYZ, his share count after receiving the dividends will be 130 in number.
Please note that this, however, will have no impact on shareholders wealth at the time of issuance.
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Small vs Large Stock Dividends
Depending on the percentage of shares issued to the total value of shares outstanding before dividend, a this can be small or large.
When the total number of shares issued is less than twenty-five percent of the entire value of shares that were outstanding before dividend, it is called a small stock dividend payout. On the other hand, if the total number of shares issued is more than twenty-five percent of the entire value of shares that were outstanding before dividend, it is called a large stock dividend payout.
Below diagram shows how the stock dividend accounting is done when the issue is small and large.
Small Stock Dividend Example (Small Issue)
90 Degree Corp has declares and issues a 20% stock dividend. On the date of declaration, the stock sells at $50/share. Show the accounting entries
Below table shows the stock dividend accounting in case of small issue.
- Common Stock increases by an additional 20% = $1 x 10,000 x 20% = 2000. Total Common Stock becomes 12,000
- Additional paid in capital due to Stock Dividends = ($50 – $1) x 10,000 x 20% = $98,000
- Retained Earnings reduces by $150,000 – $100,000 = $50,000
Stock Dividend Eample (Large Issue)
90 Degree Corp has declares and issues a 40% stock dividend. On the date of declaration, the stock sells at $50/share. Show the accounting entries
Below table shows the stock dividend accounting in case of large issue.
- Common stock increases by 40% to 14,000
- There is no change in the Additional Paid-in-Capital
- Retained Earnings is reduced by $4000.
Income Tax treatment for stock dividend payout
In most countries, there are no tax consequences on the investor or shareholder as a repercussion of stock dividend payout. This is unlike the cash dividend payouts made to shareholders which are subject to taxation.
Advantages When a Company Pay Stock Dividends
- From the company’s perspective, the main advantage they have with paying the dividend is saving the company’s cash position. Whenever the company doesn’t have enough cash to pay dividends to its shareholders, it can pay in terms of shares. Thus, effectively costing nothing in return to the company.
- Since there aren’t any tax considerations, it is beneficial for the investors as well to receive this dividend. A cash dividend is instead treated as income in the year it is received.
- Another advantage for the companies issuing stock dividends is that they might be looking at increasing liquidity of its shares by issuing more shares. This will effectively reduce the value of shares, and hence the price.
Advantages for investors investing in dividend paying stocks
Dividend-paying stocks form an important part of any investors’ portfolio. The simple reason for this is the effect of compounding.
Let us try to understand this with help of a stock dividend example.
Suppose, an investor buys stocks of a company A. Now he owns some percentage share of that company and has a fair ownership of profits on the company. Let us also assume that this company A has a history of paying stocks dividends and the investor has also received his share of this dividends. When these dividends are reinvested back into the investor’s portfolio, it has a compounded effect on their wealth.
As many times these dividends are reinvested, the investor gets more shares in his portfolio and hence, making his percentage share of ownership goes up. This in effect makes his owner in the profits with a larger proportion.
Disadvantages of Stock Dividends
- Sometimes stock dividend payout may give a signal of acute cash shortages or distress within the company
- It can also be seen that the company is involved in more risky projects and that can cast some doubts on management.
In general, a company which pays the dividend is always preferred by investors as it keeps investors excited about the return on their investments. Overall, portfolios which are focused on dividend-paying companies are able to provide a sufficient source of income to its investors. Dividend-paying stocks and companies are looked upon as the most reliable and sound investment opportunities.
This has been a guide to what is Stock Dividends? Here we take stock dividend examples and look at stock dividend accounting in case of small or large issue. In addition, we discuss the tax impact, advantages, and disadvantages of stock dividends. You may learn more about accounting from the following articles –