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 shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.—profit is further distributed among a higher number of stocks. The decision to issue dividends is made by a company’s board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. . 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.
Table of contents
- What are Stock Dividends?
- 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?
Stockholders Stockholders A stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares.are rewarded with bonus shares when they invest equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet. 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 capitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share. remains the same, but the number of outstanding common stocksCommon StocksCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity. 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 Cash DividendsCash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer., 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.
Anthony’s Stock Dividend = 7.5% of 200 = 15 Shares
Anthony’s Total Stockholding = 200 + 15 = 215 Shares
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 valuePar ValuePar value is the minimum value of a security set and stated in the corporate charter or its certificate by the issuer when issued for the first time. of the stocks is $10 per share. But, on the date of declaration, the stock sells at $50/share. Formulate the necessary accounting entriesAccounting EntriesAccounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. .
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
|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 sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. 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 entriesJournal EntriesA journal entry example would be the country's purchase of machinery, where the machinery account would be debited and the cash account would be credited. for stocks selling at $50/share (on the declaration date).
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
|Retained Earnings A/c… Dr To Common Stock A/c
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 priceMarket PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its 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 incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation..
- Positive Psychological Impact: Dividends of any kind make shareholders happy.
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)
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.
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.
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 –