Investors review the retained earnings account to determine the company’s income. The retained earnings account includes the company’s net income and dividends paid out. Dividends include both cash dividends and stock dividends. Cash dividends refer to money paid to the investor as a return of her earnings. Stock dividends refer to additional shares of stock distributed to the investor to increase her total shares. The board of directors determines when to distribute a stock dividend and how much to distribute. The company needs to know how to calculate the balance in retained earnings and the amount of the stock dividend to distribute.
1. Review the stockholder equity section of the prior year balance sheet. Locate the ending balance of retained earnings. This equals the beginning balance of retained earnings for the current year.
2. Read the current year income statement. Locate the net income. Add the net income to the beginning retained earnings balance.
3. Review the notes from the board of directors meeting. Find the stock dividend percentage declared by the board.
4. Review the common stock account. Divide the total balance by the par value of each share. This determines the number of outstanding shares.
5. Multiply the stock dividend percentage by the number of outstanding shares. This equals the amount of stock dividend distributable.
6. Subtract the amount of stock dividend distributable from the retained earnings balance. This calculates the ending retained earnings balance.
- The investor owns the same percentage of stock in the company after receiving the stock dividend as he owned before.
- Stock dividends increase the number of outstanding shares of common stock. Financial ratios calculated using the number of outstanding shares of common stock is affected by a stock dividend. For example, earnings per share divide net income by the number of outstanding shares of common stock. After the number of shares increases from the stock dividend, the earnings per share decrease.
- Cash dividends reduce the company’s cash level and total assets. Stock dividends have no impact on the company’s cash or other assets.
- The company records the impact of the distributable dividend on retained earnings before issuing the shares. The impact on retained earnings reduces retained earnings on the date of the board meeting. The company issues the shares on the date of distribution.
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