14.3: Record Transactions and the Effects on Financial Statements for Cash Dividends, Property Dividends, Stock Dividends, and Stock Splits (2024)

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Do you remember playing the board game Monopoly when you wereyounger? If you landed on the Chance space, you picked a card. TheChance card may have paid a $50 dividend. At the time, you probablywere just excited for the additional funds.

The Nature and Purposes of Dividends

Stock investors are typically driven by two factors—a desire toearn income in the form of dividends and a desire to benefit fromthe growth in the value of their investment. Members of acorporation’s board of directors understand the need to provideinvestors with a periodic return, and as a result, often declaredividends up to four times per year. However, companies can declaredividends whenever they want and are not limited in the number ofannual declarations. Dividends are a distribution of acorporation’s earnings. They are not considered expenses, and theyare not reported on the income statement. They are a distributionof the net income of a company and are not a cost of businessoperations.

CONCEPTS IN PRACTICE

So Many Dividends

The declaration and payment of dividends varies among companies.In December 2017 alone, 4,506 U.S. companies declared either cash,stock, or property dividends—the largest number of declarationssince 2004.¹²It is likely that these companies waited to declare dividends untilafter financial statements were prepared, so that the board andother executives involved in the process were able to provideestimates of the 2017 earnings.

Some companies choose not to pay dividends and instead reinvestall of their earnings back into the company. One common scenariofor situation occurs when a company experiencing rapid growth. Thecompany may want to invest all their retained earnings to supportand continue that growth. Another scenario is a mature businessthat believes retaining its earnings is more likely to result in anincreased market value and stock price. In other instances, abusiness may want to use its earnings to purchase new assets orbranch out into new areas. Most companies attempt dividendsmoothing, the practice of paying dividends that arerelatively equal period after period, even when earnings fluctuate.In exceptional circ*mstances, some corporations pay aspecial dividend, which is a one-time extradistribution of corporate earnings. A special dividend usuallystems from a period of extraordinary earnings or a specialtransaction, such as the sale of a division. Some companies, suchas Costco Wholesale Corporation,pay recurring dividends and periodically offer a special dividend.While Costco’s regular quarterlydividend is $0.57 per share, the company issued a $7.00 per sharecash dividend in 2017.¹³Companies that have both common and preferred stock must considerthe characteristics of each class of stock.

Note that dividends are distributed or paid only to shares ofstock that are outstanding. Treasury shares are not outstanding, sono dividends are declared or distributed for these shares.Regardless of the type of dividend, the declaration always causes adecrease in the retained earnings account.

Dividend Dates

A company’s board of directors has the power to formally vote todeclare dividends. The date of declaration is thedate on which the dividends become a legal liability, the date onwhich the board of directors votes to distribute the dividends.Cash and property dividends become liabilities on the declarationdate because they represent a formal obligation to distributeeconomic resources (assets) to stockholders. On the other hand,stock dividends distribute additional shares of stock, and becausestock is part of equity and not an asset, stock dividends do notbecome liabilities when declared.

At the time dividends are declared, the board establishes a dateof record and a date of payment. The date ofrecord establishes who is entitled to receive a dividend;stockholders who own stock on the date of record are entitled toreceive a dividend even if they sell it prior to the date ofpayment. Investors who purchase shares after the date of record butbefore the payment date are not entitled to receive dividends sincethey did not own the stock on the date of record. These shares aresaid to be sold ex dividend. The date ofpayment is the date that payment is issued to the investorfor the amount of the dividend declared.

Cash Dividends

Cash dividends are corporate earnings thatcompanies pass along to their shareholders. To pay a cash dividend,the corporation must meet two criteria. First, there must besufficient cash on hand to fulfill the dividend payment. Second,the company must have sufficient retained earnings; that is, itmust have enough residual assets to cover the dividend such thatthe Retained Earnings account does not become a negative (debit)amount upon declaration. On the day the board of directors votes todeclare a cash dividend, a journal entry is required to record thedeclaration as a liability.

Accounting for Cash Dividends When Only Common Stock IsIssued

Small private companies like La Cantina often have only oneclass of stock issued, common stock. Assume that on December 16, LaCantina’s board of directors declares a $0.50 per share dividend oncommon stock. As of the date of declaration, the company has 10,000shares of common stock issued and holds 800 shares as treasurystock. The total cash dividend to be paid is based on the number ofshares outstanding, which is the total shares issued less those intreasury. Outstanding shares are 10,000 – 800, or 9,200 shares. Thecash dividend is:

9,200shares×$0.50=$4,6009,200shares×$0.50=$4,600

The journal entry to record the declaration of the cashdividends involves a decrease (debit) to Retained Earnings (astockholders’ equity account) and an increase (credit) to CashDividends Payable (a liability account).

While a few companies may use a temporary account, DividendsDeclared, rather than Retained Earnings, most companies debitRetained Earnings directly. Ultimately, any dividends declaredcause a decrease to Retained Earnings.

The second significant dividend date is the date of record. Thedate of record determines which shareholders will receive thedividends. There is no journal entry recorded; the company createsa list of the stockholders that will receive dividends.

The date of payment is the third important date related todividends. This is the date that dividend payments are prepared andsent to shareholders who owned stock on the date of record. Therelated journal entry is a fulfillment of the obligationestablished on the declaration date; it reduces the Cash DividendsPayable account (with a debit) and the Cash account (with acredit).

Property Dividends

A property dividend occurs when a companydeclares and distributes assets other than cash. The dividendtypically involves either the distribution of shares of anothercompany that the issuing corporation owns (one of its assets) or adistribution of inventory. For example, Walt DisneyCompany may choose to distribute tickets to visitit* theme parks. Anheuser-BuschInBev, the company that owns the Budweiser andMichelob brands, may choose to distribute a case of beer to eachshareholder. A property dividend may be declared when a companywants to reward its investors but doesn’t have the cash todistribute, or if it needs to hold onto its existing cash for otherinvestments. Property dividends are not as common as cash or stockdividends. They are recorded at the fair market value of the assetbeing distributed. To illustrate accounting for a propertydividend, assume that Duratech Corporation has 60,000 shares of$0.50 par value common stock outstanding at the end of its secondyear of operations, and the company’s board of directors declares aproperty dividend consisting of a package of soft drinks that itproduces to each holder of common stock. The retail value of eachcase is $3.50. The amount of the dividend is calculated bymultiplying the number of shares by the market value of eachpackage:

60,000shares×$3.50=$210,00060,000shares×$3.50=$210,000

The declaration to record the property dividend is a decrease(debit) to Retained Earnings for the value of the dividend and anincrease (credit) to Property Dividends Payable for the$210,000.

The journal entry to distribute the soft drinks on January 14decreases both the Property Dividends Payable account (debit) andthe Cash account (credit).

Comparing Small Stock Dividends, Large Stock Dividends, andStock Splits

Companies that do not want to issue cash or property dividendsbut still want to provide some benefit to shareholders may choosebetween small stock dividends, large stock dividends, and stocksplits. Both small and large stock dividends occur when a companydistributes additional shares of stock to existingstockholders.

There is no change in total assets, total liabilities, or totalstockholders’ equity when a small stock dividend, a large stockdividend, or a stock split occurs. Both types of stock dividendsimpact the accounts in stockholders’ equity. A stock split causesno change in any of the accounts within stockholders’ equity. Theimpact on the financial statement usually does not drive thedecision to choose between one of the stock dividend types or astock split. Instead, the decision is typically based on its effecton the market. Large stock dividends and stock splits are done inan attempt to lower the market price of the stock so that it ismore affordable to potential investors. A small stock dividend isviewed by investors as a distribution of the company’s earnings.Both small and large stock dividends cause an increase in commonstock and a decrease to retained earnings. This is a method ofcapitalizing (increasing stock) a portion of the company’s earnings(retained earnings).

Stock Dividends

Some companies issue shares of stock as a dividend rather thancash or property. This often occurs when the company hasinsufficient cash but wants to keep its investors happy. When acompany issues a stock dividend, it distributesadditional shares of stock to existing shareholders. Theseshareholders do not have to pay income taxes on stock dividendswhen they receive them; instead, they are taxed when the investorsells them in the future.

A stock dividend distributes shares so that after thedistribution, all stockholders have the exact same percentage ofownership that they held prior to the dividend. There are two typesof stock dividends—small stock dividends and large stock dividends.The key difference is that small dividends are recorded at marketvalue and large dividends are recorded at the stated or parvalue.

Small Stock Dividends

A small stock dividend occurs when a stockdividend distribution is less than 25% of the total outstandingshares based on the shares outstanding prior to the dividenddistribution. To illustrate, assume that Duratech Corporation has60,000 shares of $0.50 par value common stock outstanding at theend of its second year of operations. Duratech’s board of directorsdeclares a 5% stock dividend on the last day of the year, and themarket value of each share of stock on the same day was $9.Figure 14.9 shows the stockholders’ equity section ofDuratech’s balance sheet just prior to the stock declaration.

14.3: Record Transactions and the Effects on Financial Statements for Cash Dividends, Property Dividends, Stock Dividends, and Stock Splits (7)

The 5% common stock dividend will require the distribution of60,000 shares times 5%, or 3,000 additional shares of stock. Aninvestor who owns 100 shares will receive 5 shares in the dividenddistribution (5% × 100 shares). The journal entry to record thestock dividend declaration requires a decrease (debit) to RetainedEarnings for the market value of the shares to be distributed:3,000 shares × $9, or $27,000. An increase (credit) to the CommonStock Dividends Distributable is recorded for the par value of thestock to be distributed: 3,000 × $0.50, or $1,500. The excess ofthe market value over the par value is reported as an increase(credit) to the Additional Paid-in Capital from Common Stockaccount in the amount of $25,500.

If the company prepares a balance sheet prior to distributingthe stock dividend, the Common Stock Dividend Distributable accountis reported in the equity section of the balance sheet beneath theCommon Stock account. The journal entry to record the stockdividend distribution requires a decrease (debit) to Common StockDividend Distributable to remove the distributable amount from thataccount, $1,500, and an increase (credit) to Common Stock for thesame par value amount.

To see the effects on the balance sheet, it is helpful tocompare the stockholders’ equity section of the balance sheetbefore and after the small stock dividend.

After the distribution, the total stockholders’ equity remainsthe same as it was prior to the distribution. The amounts withinthe accounts are merely shifted from the earned capital account(Retained Earnings) to the contributed capital accounts (CommonStock and Additional Paid-in Capital). However, the number ofshares outstanding has changed. Prior to the distribution, thecompany had 60,000 shares outstanding. Just after the distribution,there are 63,000 outstanding. The difference is the 3,000additional shares of the stock dividend distribution. The companystill has the same total value of assets, so its value does notchange at the time a stock distribution occurs. The increase in thenumber of outstanding shares does not dilute the value of theshares held by the existing shareholders. The market value of theoriginal shares plus the newly issued shares is the same as themarket value of the original shares before the stock dividend. Forexample, assume an investor owns 200 shares with a market value of$10 each for a total market value of $2,000. She receives 10 sharesas a stock dividend from the company. She now has 210 shares with atotal market value of $2,000. Each share now has a theoreticalmarket value of about $9.52.

Large Stock Dividends

A large stock dividend occurs when adistribution of stock to existing shareholders is greater than 25%of the total outstanding shares just before the distribution. Theaccounting for large stock dividends differs from that of smallstock dividends because a large dividend impacts the stock’s marketvalue per share. While there may be a subsequent change in themarket price of the stock after a small dividend, it is not asabrupt as that with a large dividend.

To illustrate, assume that Duratech Corporation’s balance sheetat the end of its second year of operations shows the following inthe stockholders’ equity section prior to the declaration of alarge stock dividend.

Also assume that Duratech’s board of directors declares a 30%stock dividend on the last day of the year, when the market valueof each share of stock was $9. The 30% stock dividend will requirethe distribution of 60,000 shares times 30%, or 18,000 additionalshares of stock. An investor who owns 100 shares will receive 30shares in the dividend distribution (30% × 100 shares). The journalentry to record the stock dividend declaration requires a decrease(debit) to Retained Earnings and an increase (credit) to CommonStock Dividends Distributable for the par or stated value of theshares to be distributed: 18,000 shares × $0.50, or $9,000. Thejournal entry is:

The subsequent distribution will reduce the Common StockDividends Distributable account with a debit and increase theCommon Stock account with a credit for the $9,000.

There is no consideration of the market value in the accountingrecords for a large stock dividend because the number of sharesissued in a large dividend is large enough to impact the market; assuch, it causes an immediate reduction of the market price of thecompany’s stock.

In comparing the stockholders’ equity section of the balancesheet before and after the large stock dividend, we can see thatthe total stockholders’ equity is the same before and after thestock dividend, just as it was with a small dividend (Figure14.10).

Similar to distribution of a small dividend, the amounts withinthe accounts are shifted from the earned capital account (RetainedEarnings) to the contributed capital account (Common Stock) thoughin different amounts. The number of shares outstanding hasincreased from the 60,000 shares prior to the distribution, to the78,000 outstanding shares after the distribution. The difference isthe 18,000 additional shares in the stock dividend distribution. Nochange to the company’s assets occurred; however, the potentialsubsequent increase in market value of the company’s stock willincrease the investor’s perception of the value of the company.

Stock Splits

A traditional stock split occurs when acompany’s board of directors issue new shares to existingshareholders in place of the old shares by increasing the number ofshares and reducing the par value of each share. For example, in a2-for-1 stock split, two shares of stock are distributed for eachshare held by a shareholder. From a practical perspective,shareholders return the old shares and receive two shares for eachshare they previously owned. The new shares have half the par valueof the original shares, but now the shareholder owns twice as many.If a 5-for-1 split occurs, shareholders receive 5 new shares foreach of the original shares they owned, and the new par valueresults in one-fifth of the original par value per share.

While a company technically has no control over its common stockprice, a stock’s market value is often affected by a stock split.When a split occurs, the market value per share is reduced tobalance the increase in the number of outstanding shares. In a2-for-1 split, for example, the value per share typically will bereduced by half. As such, although the number of outstanding sharesand the price change, the total market value remains constant. Ifyou buy a candy bar for $1 and cut it in half, each half is nowworth $0.50. The total value of the candy does not increase justbecause there are more pieces.

A stock split is much like a large stock dividend in that bothare large enough to cause a change in the market price of thestock. Additionally, the split indicates that share value has beenincreasing, suggesting growth is likely to continue and result infurther increase in demand and value. Companies often make thedecision to split stock when the stock price has increased enoughto be out of line with competitors, and the business wants tocontinue to offer shares at an attractive price for smallinvestors.

CONCEPTS IN PRACTICE

Samsung Boasts a 50-to-1 Stock Split

In May of 2018, SamsungElectronics¹⁴had a 50-to-1 stock split in an attempt to make it easier forinvestors to buy its stock.Samsung’s market price of eachshare prior to the split was an incredible 2.65 won (“won” is aJapanese currency), or $2,467.48. Buying one share of stock at thisprice is rather expensive for most people. As might be expected,even after a slight drop in trading activity just after the splitannouncement, the reduced market price of the stock generated asignificant increase to investors by making the price per shareless expensive. The split caused the price to drop to 0.053 won, or$49.35 per share. This made the stock more accessible to potentialinvestors who were previously unable to afford a share at$2,467.

A reverse stock split occurs when a companyattempts to increase the market price per share by reducing thenumber of shares of stock. For example, a 1-for-3 stock split iscalled a reverse split since it reduces the number of shares ofstock outstanding by two-thirds and triples the par or stated valueper share. The effect on the market is to increase the market valueper share. A primary motivator of companies invoking reverse splitsis to avoid being delisted and taken off a stock exchange forfailure to maintain the exchange’s minimum share price.

Accounting for stock splits is quite simple. No journal entry isrecorded for a stock split. Instead, the company prepares a memoentry in its journal that indicates the nature of the stock splitand indicates the new par value. The balance sheet will reflect thenew par value and the new number of shares authorized, issued, andoutstanding after the stock split. To illustrate, assume thatDuratech’s board of directors declares a 4-for-1 common stock spliton its $0.50 par value stock. Just before the split, the companyhas 60,000 shares of common stock outstanding, and its stock wasselling at $24 per share. The split causes the number of sharesoutstanding to increase by four times to 240,000 shares (4 ×60,000), and the par value to decline to one-fourth of its originalvalue, to $0.125 per share ($0.50 ÷ 4). No change occurs to thedollar amount of any general ledger account.

The split typically causes the market price of stock to declineimmediately to one-fourth of the original value—from the $24 pershare pre-split price to approximately $6 per share post-split ($24÷ 4), because the total value of the company did not change as aresult of the split. The total stockholders’ equity on thecompany’s balance sheet before and after the split remain thesame.

THINK IT THROUGH

Accounting for a Stock Split

You have just obtained your MBA and obtained your dream job witha large corporation as a manager trainee in the corporateaccounting department. Your employer plans to offer a 3-for-2 stocksplit. Briefly indicate the accounting entries necessary torecognize the split in the company’s accounting records and theeffect the split will have on the company’s balance sheet.

YOUR TURN

Dividend Accounting

Cynadyne, Inc.’s has 4,000 shares of $0.20 par value commonstock authorized, 2,800 issued, and 400 shares held in treasury atthe end of its first year of operations. On May 1, the companydeclared a $1 per share cash dividend, with a date of record on May12, to be paid on May 25. What journal entries will be prepared torecord the dividends?

Solution

A journal entry for the dividend declaration and a journal entryfor the cash payout:

To record the declaration:

Date of declaration, May 12, no entry.

To record the payment:

THINK IT THROUGH

Recording Stock Transactions

In your first year of operations the following transactionsoccur for a company:

Net profit for the year is $16,000
100 shares of $1 par value common stock are issued for $32 pershare
The company purchases 10 shares at $35 per share
The company pays a cash dividend of $1.50 per share

Prepare journal entries for the above transactions and providethe balance in the following accounts: Common Stock, Dividends,Paid-in Capital, Retained Earnings, and Treasury Stock.

Footnotes

12 Ironman at Political Calculations. “Dividends by theNumbers through January 2018.” Seeking Alpha. February 9, 2018.seekingalpha.com/article/414...s-january-2018
13 Jing Pan. “Will Costco Wholesale Corporation Pay aSpecial Dividend in 2018?” Income Investors. May 9, 2018. https://www.incomeinvestors.com/will...nd-2018/38865/
14 Joyce Lee. “Trading in Samsung Electronics Shares Surgesafter Stock Split.” Reuters. May 3,2018. https://www.reuters.com/article/us-s...-idUSKBN1I500B