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Stock Dividend

Updated on June 19, 2024
Article byWallstreetmojo Team
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What are Stock Dividends?

A stock dividend refers to bonus shares paid to shareholders instead of cash. Companies resort to such dividends when there is a cash crunch. Shareholders are allotted a certain percentage of shareholding.

Stock dividends decrease earnings per share—profit is further distributed among a higher number of stocks. The decision to issue dividends is made by a company’s board of directors. The issuance of bonus shares is a strategy to encourage shareholders—investors get a healthy return, and the company does not have to part with capital.

Key Takeaways

  • A stock dividend is a compensation provided to a stockholder for staying invested in the company. It is in the form of bonus shares.
  • There are two forms of stock dividends—small and large. While the former has a dividend percentage below 25%, the latter has a higher percentage. 
  • It is the opposite of cash dividends, where investors and shareholders are rewarded in cash.

How Do Stock Dividends Work?

Stock Dividend

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Stockholders are rewarded with bonus shares when they invest equity in a company; these shares are called stock dividends. It will not impact the shareholder’s wealth at the time of stock issuance but increase the volume of their shareholding. But when companies offer bonus shares, the price per share falls. The company’s market capitalization remains the same, but the number of outstanding common stocks increases.

If the company grows and stock prices rise considerably, the received bonus shares may provide high returns to the investors at the time of selling. Also, unlike cash dividends, in most countries, bonus shares don’t add to tax liability.

Stock Dividend Explained in Video

Stock Dividend Examples

Let us assume that XYZ Corp has announced a dividend of 7.5%. If Anthony holds 200 shares in the company, how much stock dividend will he yield? Also, determine the total stocks held by Anthony.

Solution:

Anthony’s Stock Dividend = 7.5% of 200 = 15 Shares

Anthony’s Total Stockholding = 200 + 15 = 215 Shares

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Stock Dividend Calculation and Journal Entries

There are two forms of bonus shares:

#1 – Small Stock Dividends

When the total number of shares issued is less than twenty-five percent of the entire value of outstanding shares before the dividend, it is called a small dividend payout.

For instance, 90 Degree Corp holds 10,000 common stocks. The company declares and issues a 20% dividend. The par value of the stocks is $10 per share. But, on the date of declaration, the stock sells at $50/share. Formulate the necessary accounting entries.

Solution:

Number of stocks issued as dividend = 20% of 10000 = 2000 stocks

Total outstanding common stocks = 10000 + 2000 = 12000 stocks

Retained Earnings = $50 x 2000 stocks = $100000

Common Stocks = $10 x 2000 stocks = $20000

Paid in Capital = ($50 – $10) x 2000 stocks = $80000

Journal Entries:

ParticularsDebit ($)Credit ($)
Retained Earnings A/c…                              Dr    To Common Stock A/c    To Paid in Capital A/c                                          100000 – –– 20000 80000

#2 – Large Stock Dividends

If the total number of shares issued is more than twenty-five percent of the entire value of outstanding shares before the dividend, it is called a large dividend payout.

Let us assume 90 Degree Corp has 10000 common stocks each of $10 par value. The company declares a 30% dividend. Formulate necessary journal entries for stocks selling at $50/share (on the declaration date).

Solution:

Number of stocks issued as dividend = 30% of 10000 = 3000 stocks

Total outstanding common stocks = 10000 + 3000 = 13000 stocks

Retained Earnings = $50 x 3000 stocks = $150000

Journal Entries:

ParticularsDebit ($)Credit ($)
Retained Earnings A/c…                              Dr    To Common Stock A/c150000 –– 150000

Advantages

Bonus shares are a great option, not only for dividend-paying companies but also for investors. The advantages are as follows:

  • Cash Balance Remains Unaffected: Since dividends are paid in the form of shares, the company’s cash balance doesn’t change. 
  • Satisfied Shareholders: Even when the company doesn’t have enough money to reward the stockholders, paying bonus shares increases stockholders’ loyalty and satisfaction.
  • Attracts Investors: Stock dividend payouts reduce the market price of the stocks—more affordable for the investors.
  • High Future Returns: Shareholders can reap huge profits by holding on to promising stocks long-term. They can sell the shares when the prices skyrocket.
  • Tax Benefit: With bonus shares, shareholders’ tax liability is brought down. Cash dividends, on the other hand, are treated as taxable income.  
  • Positive Psychological Impact: Dividends of any kind make shareholders happy.

Disadvantages

There are drawbacks too. Bonus shares further dilute the share price and distribute the equity ownership. Moreover, bonus shares don’t add any real value—they are adjusted in the stock price. Sometimes, bonus shares hint at an acute cash shortage faced by a company. Investors often equate bonus shares with a company being involved in more risky projects—casting doubts and suspicion.

Stock Dividend Vs. Cash Dividend

If we compare stock dividends with cash dividends, the former is the issuance of additional shares to the existing shareholders. The latter refers to shareholders getting paid in cash in lieu of investments made in the company.

Bonus shares dilute a company’s stake, whereas cash dividends decrease cash reserves. Companies resort to bonus shares when there is a cash shortage. Bonus shares increase investors’ shareholding, whereas cash dividends immediately provide financial benefits to the shareholders.

In comparison, bonus shares pose a higher risk for the shareholders. Cash dividends, on the other hand, are risk-free rewards. When it comes to tax liability, bonus shares are mostly tax-free. On the other hand, shareholders get taxed for receiving cash dividends.

Frequently Asked Questions (FAQs)

Which is the best stock dividend?

AT&T Inc. (T) is the best dividend-paying company, according to In S&P 500—with a dividend yield of 8.6%. It is closely followed by Lumen Technologies Inc. (LUMN) and Altria Group Inc. (MO) —yielding 7.9% and 7.1%, respectively.

Who pays stock dividends?

The company gives bonus shares to shareholders. It is a percentage of the stockholding. As a result, the company does not have to pay any cash.

How are dividends calculated?

The formula for computing the dividend is as follows:
Dividend = Annual Net Income – Change in Retained Earnings
Here, Change in Retained Earnings = Closing Balance of Retained Earnings – Opening Balance of Retained Earnings.

This has been a guide to what is Stock Dividend and its Meaning. Here we discuss stock dividend payouts, calculations, journal entries, cash dividends, and list examples of best yielding dividends like at&t. You may learn more about accounting from the following articles –