What are small stock dividends?
The treatment of small stock dividends differs from the one used for splits effected as dividends because they serve fundamentally different purposes. A small stock dividend is treated as if it is a cash dividend reinvested in capital stock. Consequently, Retained Earnings should be debited for the market value of stock and the credits should be recorded in the Capital Stock and Capital in Excess of Par accounts.
The Committee on Accounting Procedure justified this approach on the grounds that the dividend is perceived as a reinvestment. While specifying that the market value be used, did not specify the day (declaration or distribution) on which the market value is to be measured. It seems that the declaration date is more appropriate because the information available at that date was relied upon by the board when deciding whether to declare the dividend.
Large versus Small Stock Dividends
Up to the point, we have been discussing small stock dividends, which range to 20 or 25%. Occasionally a corporation will issue a large stock dividend. The accounting profession defines a large stock dividend as one in excess of 20 to 25%. Some stock dividends are as large as 100%, and these have the effect of proportionately reducing the market price of the corporation’s stock. Large stock dividends are recorded by debiting Retained Earnings and crediting Common Stock for the total par value of the stock issued by the stock dividend. The market value of the stock is ignored.
Identifying small and large stock dividends
The accountant must be able to identify whether a particular stock dividend is small or large. The key factor cited by the committee is the management’s intent. If the objective of the board of directors was to produce a stimulation of market activity, the dividend should be accounted for as a large dividend. While this test may be theoretically sound, it depends on subjective evidence. In recognition of this weakness, the accountant examines the dividend’s effect on the stock’s market value. That is, if the value apparently drops because the dividend was declared, then it should be considered large. However, this test also relies on potentially inadequate evidence in the sense that the accountant simply may not be able to determine whether it was the dividend or other factors that caused the price to change.
Consequently, the committee established a third test that depends on the size of the dividend compared to the number of shares outstanding prior to its declaration. While the percentage size can be easily and objectively calculated, the committee did not establish a specific dividing point between small and large.
Perhaps because this imprecise guideline left an unsatisfactorily high degree of judgment in the test, the SEC issued Accounting Series Release. This pronouncement holds that all dividends less than or equal to 25 percent are small and all others are large. Even though the SEC rule technically applies only to firms under the commission’s jurisdiction, it appears to have been very influential in establishing generally accepted practice.
Example (How to pay Small Stock Dividends?)
The following example presents the disclosure by Checker Motors Corporation related to the declaration and payment of a small stock dividend.
In February 2019 the Board of Directors approved a 2-for-1 split of the Company’s common stock in the form of a 100% stock dividend. In order to effect this stock split, the stockholders approved an increase in the authorized common stock from 10,000,000 to 25,000,000 shares. All references to per share data and stock option data have been adjusted to reflect this stock split.