Study Notes on Dividends and Stockholders' Equity

Stock Dividends

  • A company can declare a stock dividend instead of a cash dividend by distributing shares of their stock.
  • Typically, only common stockholders receive stock dividends.
  • The value of a stock dividend is the same as a cash dividend, but it's distributed as shares based on the current market price.

Example: Hendrix Corporation

  • Common stock: 2,000,0002,000,000 shares issued, $20 par.
  • Paid-in capital in excess of par: 9,000,0009,000,000.
  • Retained earnings: 26,600,00026,600,000.
  • Stock dividend: 5% or 100,000100,000 shares.
  • Record date: December 31.
  • Market price on December 15: $31 per share (used for calculation).
Calculation:
  • 100,000100,000 shares at $20 par = 2,000,0002,000,000 (Stock Dividends)
  • Additional paid-in capital in excess of par: 1,100,0001,100,000.
  • Total dividends: 3,100,0003,100,000 (agrees to market value on the declaration date).
Accounting:
  • Create a liability account: Stock Dividends Distributable.
  • Debit: Stock Dividends, $2,000,000
  • Credit: Additional Paid-in Capital, $1,100,000
  • Credit: Stock Dividends Distributable, $3,100,000
Distribution:
  • On January 10, distribute the stock dividend.
  • Debit Stock Dividends Distributable and credit Common Stock.
  • A stock dividend only changes the equity section of the balance sheet.
  • It does not change individual stockholders' proportional interest.
  • Example: If a stockholder owns 1,000 of 10,000 shares (10%), a 6% stock dividend gives them an additional 600 shares, maintaining their 10% ownership.

Stock Split

  • Reduces the par value of stock and issues a proportionate number of additional shares.
  • Applied to common stock, both unissued and issued shares.
  • Objective: To reduce the market price of the stock, especially when it becomes very high (e.g., $1500-2000 per share).

Example

  • Corporation has 10,000 shares of $100 par common stock with a market price of $150 per share.
  • Declares a five-for-one stock split.
  • Each shareholder gets five shares for each share held.
  • Result: 50,000 shares outstanding, and the par value is reduced to $20 ($100 / 5).
  • The overall value remains the same, the number of shares and authorized shares both increase.
  • Each shareholder owns the same total par amount of stock before and after the split.
  • Before the split: Four shares of $100 par value stock.
  • After a five-for-one stock split: 20 shares (4 * 5) of $20 par ($100 / 5).
  • Total value remains the same.

Treasury Stock

  • Stock that has been issued and then bought back by the company (contra equity account).

Reasons for Buying Back Stock

  • To provide shares for resale to employees (stock options).
  • To reissue as bonuses to employees.
  • To affect the market price of the stock.

Accounting Method

  • Cost method is typically used.
  • New equity section account: Treasury Stock (debit balance).
  • Additional equity account: Paid-in Capital from Sale of Treasury Stock (credit any difference between cost and selling price).

Example

  • Balances as of January:

    • Common stock: 2525 par, 20,000 shares authorized and issued.
    • Paid in Capital in Excess of Par

  • February 13: Purchased 1,000 shares of its common stock at $45 per share.

    • Debit: Treasury Stock, $45,000
    • Credit: Cash, $45,000

  • April 29: Sold 600 shares of the treasury stock for $60.

    • Treasury stock purchased at $45.
    • Credit: Treasury Stock, $27,000 (600 * $45)
    • Credit: Paid-in Capital from Sale of Treasury Stock, $9,000 (($60 - $45) * 600)
    • Debit : Cash, $36,000

  • October 4: Sold the remaining 400 shares of treasury stock for $40.

    • Treasury stock purchased at $45.
    • Credit: Treasury Stock, $18,000 (400 * $45)
    • Debit: Paid-in Capital from Sale of Treasury Stock, $2,000 (($45 - $40) * 400)
    • Debit : Cash, $16,000

  • No cash dividends are paid on treasury stock because the corporation cannot pay dividends to itself.

Reporting Stockholders’ Equity

  • The names of items in stockholders' equity change based on the type of legal entity but generally mean the same thing.
  • Changes in Retained Earnings and Paid-in Capital are typically reported in a separate statement or in the notes to the financial statements.

Methods for Presenting on the Balance Sheet

  • Method 1:
    • Report each class of stock followed by its related paid-in capital accounts.
    • Report retained earnings separately with a deduction for treasury stock.
  • Method 2:
    • Report stock accounts.
    • Report paid-in capital as a single item called additional paid-in capital.
    • Report retained earnings separately with a reduction for treasury stock.

Reporting Retained Earnings

  • Can be reported in a separate statement or combined with the income statement.
  • When doing a separate retained earnings statement, disclose the beginning balance, report any changes, and combine with the income statement.
  • Start with the beginning balance at the beginning of the period, add in net income, subtract out any dividends, and arrive at the retained earnings at the end of the year.

Restrictions on Retained Earnings

  • Restrictions can be due to:
    • Appropriation by the board of directors.
    • Legal requirements (state law).
    • Contractual agreements.
    • Discretionary actions by the board of directors.
  • If there is a restriction, disclose it in the financial statements.

Prior Period Adjustments

  • Corrections to errors in prior financial statements discovered after publication which could be a mistake in accounting principle.
  • Effect of the error should not affect the current period.
  • Correction is called a prior-year adjustment and is reported as an adjustment to the beginning balance of retained earnings.

Statement of Stockholders’ Equity

  • Prepared with columns for each stock class to disclose any changes in each transaction.
  • Columns for preferred stock, common stock, additional paid-in capital, retained earnings, and treasury stock.

Earnings Per Share (EPS)

  • One of the most used ratios for analyzing stock performance.
  • Tells how much net income the company had for each share of common stock.
  • Must be disclosed on financial statements if the stock is traded on a stock exchange.
  • Formula:
    • EPS=(NetIncome−PreferredDividends)/AverageNumberofCommonSharesOutstandingEPS = (Net Income - Preferred Dividends) / Average Number of Common Shares Outstanding

Meta Platforms Example

  • Net income for a recent year: $39,000,000.
  • Net income for the prior year: $29,000,000.
  • Average shares of common shares outstanding: 2,851,000 in the recent year and 2,815,000 in the previous year.
  • EPS increased due to higher income.