Can you explain to me the small stock dividend and big stock dividend?
The key difference between small stock dividends and large stock dividends is whether we use par value or fair value to record the transaction.
For small stock dividends, we debit retained earnings for fair value of the dividend and credit common stock and APIC to offset the debit. Small stock dividends are defined as stock dividends that are less than 20-25% of outstanding shares.
For large stock dividends, we debit retained earnings for par value and we credit common stock. Large stock dividends are defined as stock dividends that are more than 20-25% of outstanding shares.
The logic for this distinction is that investors view dividends as a distribution of corporate earnings. If small stock dividends are not recorded at fair value (i.e. less is taken out of retained earnings), it appears the company has more funds available to distribute to shareholders as dividends. In addition, small stock dividends are unlikely to impact the share price, so if the share price remains the same as it was before the dividend and you now have more shares, you have made money.
For large stock dividends, the share price is likely to be impacted. For instance, if a stock is trading at $60 and there is a 100% stock dividend, the market will react and the stock price will be cut in half since all investors now own 2 times as many shares. If you double the shares, but the price is cut in half, you have not made any money on the stock dividend. As a result, large stock dividends are accounted for at par value instead of fair value.
Follow Up Question:
Hi Rob. Thanks for the explanation. Large stock is par value and small stock is fair value. Is that understanding enough? What happens if it is between 20 to 25?
Right, a large dividend is at par and a small dividend is at fair value. The 20-25% is meant to be a guideline to distinguish between large and small. The standard setters did not want a “bright line,” but rather wanted to provide a guide. A 20% stock dividend may be treated as a large stock dividend if the dividend significantly impacts the share price. Conversely, a 25% stock dividend may not significantly impact the share price and would be treated as a small stock dividend. The treatment is based on the individual facts and circumstances of each dividend. This was a long way of saying that there is no 3rd category between 20-25%.