Definition: A small stock dividend is distribution of 25 percent or less outstanding company shares to existing stockholders. In other words, it’s a stock dividend that increases outstanding shares by less than 26% by issuing new shares to current investors based on their ownership percentage. In effect a distribution of stock transfers part of retained earnings to the contributed capital accounts on the balance sheet.
What Does Small Stock Dividend Mean?
Stock dividends are common in corporate structures where the company doesn’t have enough cash or cash flow to pay investors. Instead of issuing cash dividends, the board of directors declares a stock dividend to keep investors happy. This way investors still get a return on their investment and the corporation doesn’t have to deplete its cash position. These dividends are also common in mergers and corporate restructuring deals.
Let’s take a look at an example of how a stock dividend works. Currently, Krispy’s Bakery has 10,000 outstanding $10 par shares of stock and is authorized to issue another 5,000. Its retained earnings account has a $20,000 balance and the market value of each share is $25. The Krispy board of directors declares a 10% stock to all the current stockholders. This means the total number of outstanding shares will increase 10% after the dividend is issued.
On the date of issuance, 10% more shares will be issued to each shareholder based on their ownership percentage on the day of declaration. This business transaction is recorded by capitalizing the market value of the newly issued and distributed shares. Krispy’s journal entry to record this would event would debit retained earnings for $25,000, credit the common stock account for $10,000, and credit the paid in capital account for $5,000.
As you can see, the small stock dividend transfers $25,000 of retained earnings to common stock (equal to the par value) and paid in capital (equal to the difference between the market value per share and the par value).