Most dividend investors are used to receiving cash from the companies whose shares they own. However, there are actually two different types of dividends: cash dividends and stock dividends. The ways that you account for these two dividend types differs, and understanding how it works is critical both for accounting professionals and for investors in these stocks.
Cash dividends: the simple choiceFor investors, cash dividends couldn't be simpler. The company establishes how much in cash each investor receives per share owned. To figure out what you'll receive, multiply the number of shares you own by the dividend amount.
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From an accounting perspective, when a company declares a cash dividend, it sets aside the money it will pay in dividends in its Dividends Payable account, moving the money from Retained Earnings. When it later pays the dividend, it zeros out the Dividends Payable account and reduces the Cash line item by what it pays.
How stock dividends workBy contrast, stock dividends don't result in any cash changing hands. The company establishes a percentage rate for the dividend, and investors receive new shares that correspond to that percentage. For example, if a company sets a 5% stock dividend, then an investor who owns 100 shares will receive a stock dividend of five shares.
Accounting for stock dividends depends on the size of the percentage. For a stock dividend of more than 25%, when the dividend is declared, you'll reduce Retained Earnings and create a Common Stock Dividend Distributable account. On the issue date, you'll zero out the Common Stock Dividend Distributable account and increase the Common Stock line item.
If the stock dividend is 25% or less, then you'll need to consider the par value of the stock. The initial reduction in Retained Earnings will include the full market value of the dividend shares issued, but only the part attributable to the par value of the stock will go toward the Common Stock Dividend Distributable account. The remainder will go toward the Paid-In Capital in Excess of Par line item. Then, when the stock is issued, the only change is to move the par value amount from Common Stock Dividend Distributable to the Common Stock line.
Accounting for stock dividends is more complicated than cash dividends, but stock dividends have the benefit of not requiring a company to come up with cash. That can be especially useful for young companies without much cash to distribute.
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The article What Is the Effect of a Stock Dividend Declared and Issued vs. a Cash Dividend Declared and Paid? originally appeared on Fool.com.
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