A stock dividend is a dividend paid in the form of additional shares rather than cash. Each shareholder receives new shares in proportion to the shares already held: a 10 percent stock dividend gives a holder of 100 shares another 10. No cash leaves the company, no assets change and each shareholder's percentage ownership stays the same. In accounting terms, part of retained earnings is reclassified into contributed capital, so the composition of stockholders' equity changes but its total does not.
Companies issue stock dividends to reward shareholders while conserving cash, to signal confidence, to bring down the market price per share without a formal split, or to capitalize part of retained earnings so it cannot later be paid out as cash dividends. Stock dividends are different from a property dividend, which distributes non-cash assets, and from a stock split, which is accounted for differently.
Small and large stock dividends
US GAAP draws a line based on the size of the distribution:
- A small stock dividend, generally less than 20 to 25 percent of the shares outstanding, is assumed not to affect the market price much. It is recorded at the fair value of the shares distributed. Retained earnings is reduced by that value, common stock is credited for the par value of the new shares, and the excess is credited to additional paid-in capital.
- A large stock dividend, more than 20 to 25 percent, is expected to reduce the share price proportionately, much like a split. It is recorded at par or stated value only, so retained earnings is reduced by the par value of the new shares.
Worked example
A company has 1,000,000 shares of $1 par common stock outstanding, trading at $30. Retained earnings are $12,000,000.
It declares a 10 percent stock dividend, distributing 100,000 new shares. This is a small stock dividend, valued at 100,000 times $30, or $3,000,000. On the declaration date the company debits retained earnings $3,000,000, credits common stock dividend distributable $100,000 and credits paid-in capital in excess of par $2,900,000. Stock dividend distributable is shown within equity, not as a liability, because no assets will be paid out. On the distribution date it debits common stock dividend distributable and credits common stock for $100,000. Retained earnings fall to $9,000,000; total equity is unchanged.
If instead the company declared a 50 percent stock dividend, it would issue 500,000 shares and record only their par value, debiting retained earnings and crediting common stock for $500,000.
For a shareholder with 1,000 shares worth $30,000 before a 10 percent dividend, the holding becomes 1,100 shares. In theory the share price falls to about $27.27, leaving the investment worth the same $30,000.
Because the number of outstanding shares increases, earnings per share and dividends per share fall. Accounting standards require the new share count to be applied retroactively to all periods presented, so EPS for earlier years is restated as if the stock dividend had always been in effect. This keeps trends comparable. If net income was $4,400,000, EPS would be $4.00 on 1,100,000 shares, and prior year figures would be restated using the higher count.
Tax and practical points
In the United States, a pro rata stock dividend of common stock on common stock is generally not taxable to shareholders when received under Section 305 of the Internal Revenue Code. Instead, the shareholder's original cost basis is spread over the larger number of shares. A stock dividend becomes taxable if shareholders can choose cash instead, or if it changes their proportionate interests. Under IFRS there is no specific standard for stock dividends, and practice in many countries, where they are often called bonus issues or scrip dividends, varies, though the transfer within equity is similar. Stock dividends do not create value by themselves; markets react mainly to what they signal about the company's prospects and its cash dividend policy.