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Stock Dividends and Stock Splits

Stock Dividend

A stock dividend is a dividend paid by the distribution of additional shares to existing shareholders rather than paying cash. A stock dividend does not create a liability for the company or require the use of existing assets to pay. Similarly, new shares are not exchanged for consideration. After a stock dividend is issued the corporation will have the same total book value as before the dividend and the shareholders will have the same proportionate ownership in the corporation. 

When a stock dividend is issued, the fair value of the shares issued should be removed from retained earnings and transferred into capital stock and additional paid in capital (this is called "capitalizing" retained earnings). This is because the shareholders who receives the stock dividend will believe that an amount from the corporations retained earnings is being distributed to them. If this amount is not transfered out of retained earnings, then the same amount could be subject to other further stock or cash dividends.1 US GAAP recognizes that most laws only require the par value of the shares to be capitalized, not the fair value. GAAP reaffirms that the law, in these circumstances, should only be treated as a minimum requirement and GAAP should still apply.2  



If the stock dividend is declared before it is distributed "dividends payable" would be credited instead of "common shares". Then when the dividend is distributed common shares would be credited and dividends payable would be debited.

Stock Split

A stock split occurs when a corporation divides its existing shares into multiple shares. This is done in order to reduce the market price of the shares in order to make them more liquid in the open market. A stock split is conceptually the same as a stock dividend. However, FASB requires that a stock dividend be treated as a stock split if the dividend becomes materially large enough to affect the unit price of the stock. In most cases, a new stock issuance of less than 20 to 25 percent of the previously outstanding shares would be considered a stock dividend.3  

A stock split does not require the capitalization of retained earnings. 


References:

1. FASB ASC 505-20-30-3
2. FASB ASC 505-20-30-4
3. FASB ASC 505-20-25-3

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