Case Analysis 15-4

The directors of Merchant Corporation are considering the issuance of a stock dividend. They have asked you to discuss the proposed action by answering the following questions.

Instructions

a. What is a stock dividend? How is a stock dividend distinguished from a stock split (1) from a legal standpoint, and (2) from an accounting standpoint?

b. For what reasons does a corporation usually declare a stock dividend? A stock split?

c. Discuss the amount, if any, of retained earnings to be capitalized in connection with a stock dividend.

A stock dividend is the issuance by a corporation of its own stock to its stockholders on a prorate basis without receiving payment there for. The stock dividend itself results in an increase in the amount of the legal or state capital of the corporation. The dividend may be charged to retained earnings or to any other capital account that is not a part of legal capital. From a legal standpoint, a stock split is distinguished from a stock split in that a split results in an increase in the number of shares outstanding and a decrease in the par or stated value per share. Although it results in an increase in the number of shares outstanding, a stock dividend does not result in a decrease in the par or stated value of the shares. The major distinction is that a stock dividend requires a journal entry to decrease retained earnings and increase paid-in capital, while there is no entry for a stock split. Also, from the accounting standpoint the distinction between a stock dividend and a stock split is dependent upon the intent of the board of directors in making the declaration. If the intent is to give to stockholders some separate evidence of a part of their prorate interests in accumulated corporate earnings, the action results in a stock dividend. If the intent is to issue enough shares to reduce the market price per share of the stock, the action results in a stock split, regardless of the form it may take. In other words,...