How Dividends Affect Stockholder Equity

do stock dividends decrease retained earnings

After a 10 percent stock dividend, the stockholder still owns percent of the outstanding shares – 1,100 of the 110,000 outstanding shares. After original issuance, investors may trade the stock of a company on
secondary markets, such as the New York Stock Exchange. The
company makes no entry on its books for these outside trades after issuance. Often, a company uses a spreadsheet or database program
to note trades between shareholders.

However, many people feel this is unfair because the company that pays the dividend must do so with after-tax dollars. In other words, the company must first pay income tax on its profits, and then use what is left over to pay for the dividend. Then the shareholders, who receive the dividend, must pay tax on it for a second time. On a particular day, called the “declaration date,” the board of directors announces they will pay a dividend and specifies how much it will be.

Accounting for a Cash Dividend

South Korea’s major exporters, particularly in the automotive and smartphone industries, have been making headlines this year for bringing home a larger portion of their earnings. This move is driven by new tax breaks introduced by the government, which provide incentives for companies to repatriate their profits. By doing so, these companies can enjoy the benefits of reduced tax burdens and potentially invest the retained earnings in further growth and development. Fleetwood Enterprises, Inc., is the nation’s leading producer of
manufactured housing and recreational vehicles. Therefore,
companies try to maintain a record of paying dividends, as Fleetwood
noted in a 2001 press release.

Many people invest in certain stocks at certain times solely to collect dividend payments. Some investors purchase shares just before the ex-dividend date and then sell them again right after the date of record—a tactic that can result in a tidy profit if it is done correctly. Suppose Company X declares a 10% stock dividend on its 500,000 shares of common stock. Its common stock has a par value of $1 per share and a market price of $5 per share. Issuing share dividends lowers the price of the stock, at least in the short term.

Definition of Dividends

Even if the dividends are issued in the form of shares, though, they will still be taxable in the year in which they were earned. The move by Apple’s Board of Directors not only put real cash into the hands of the shareholders, it also, indirectly, benefited the shareholders in another way for two reasons. First, do stock dividends decrease retained earnings in order to generate income, many people choose to invest in stocks that pay dividends. A lot of these people will buy Apple stock now that it has agreed to provide regular income to its shareholders. Second, many so-called “value-oriented” mutual funds are not allowed to buy stocks that do not pay dividends.

do stock dividends decrease retained earnings

When a company earns profits, it has several options on how to allocate those earnings. One option is to distribute them to shareholders as dividends, while the other option is to retain them within the company. These retained earnings become part of the company’s equity and are reflected on the balance sheet. On the other hand, retained earnings represent the accumulated profits that a company has retained or reinvested back into the business. These earnings are not distributed to shareholders but are instead kept within the company to finance growth initiatives, repay debt, or build cash reserves. When a company is doing well and wants to reward its shareholders for their investment, it issues a dividend.

What Are Cash Dividends?

Because dividends are issued from a company’s retained earnings, only companies that are substantially profitable issue dividends with any consistency. When the small stock dividend is declared, the market price of $5 per share is used to assign the value to the dividend as $250,000 — calculated by multiplying 500,000 x 10% x $5. Like any stock shares, stock dividends are not taxed until the investor sells the shares. Now, when someone buys or sells shares of stock, it takes time to register the transaction with the company. When this happens, we say that the trade has “settled.” In the United States, it takes three business days for stock market trades to settle. Thus, if someone wants to purchase shares of a company in order to receive an upcoming dividend, he or she must buy those shares at least three days before the record date.

In conclusion, dividends and retained earnings are two essential financial concepts that should be carefully managed for long-term success. Paying dividends can provide immediate value to shareholders, while retaining earnings enables companies to fuel growth and fund future initiatives. Companies must carefully consider these factors when formulating their dividend policies to strike a balance between providing value to shareholders and retaining earnings for future business needs.

Example of stock dividend dilution

Corporations usually account for stock dividends by transferring a sum from
retained earnings to permanent paid-in capital. The amount transferred for stock
dividends depends on the size of the stock dividend. For stock dividends, most states
permit corporations to debit Retained Earnings or any paid-in capital accounts other
than those representing legal capital. In most circumstances, however, they debit
Retained Earnings when a stock dividend is declared. To illustrate how these three dates relate to an actual situation, assume the board
of directors of the Allen Corporation declared a cash dividend on 2010 May 5, (date
of declaration).

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