While most dividends are paid in cash, some companies choose to pay dividends in stock. This situation can arise when a company has a legal obligation to pay a dividend, but does not have enough liquidity to pay a dividend in cash.
A common stock dividend distributable appears in the shareholders' equity section of a balance sheet, whereas cash dividends distributable appear in the liabilities section. To understand why, you have to understand the accounting behind stock dividends.
How the accounting works
We can use an example to help explain how common stock dividends affect the balance sheet. Before the common stock dividend is declared, assume that Foolish Company has a shareholders' equity section that looks like this:
Common stock (par value $1, 1,000 shares outstanding): $1,000
Total paid-in capital $1,000
Retained earnings: $2,000
Shareholders' equity: $3,000
Now, assume that the company declares a stock dividend of 0.1 shares for every share outstanding, resulting in the issuance of 100 new shares. The current market value for the stock is $8 per share. On the declaration date, the company's shareholders' equity section would look like this:
Common stock (par value $1, 1,000 shares outstanding): $1,000
Stock dividend distributable: $100
Paid-in capital in excess of par from stock dividend distributable: $700
Total paid-in capital: $1,800
Retained earnings: $1,200
Shareholders' equity: $3,000
Notice that shareholders' equity is unchanged. However, $100 is added to stock dividend distributable to reflect the par value of the 100 shares to be issued. Paid-in capital in excess of par from stock dividend distributable (that's a mouthful!) is increased by $700 to reflect the difference between the market value of the stock dividend ($800), and the par value of the stock dividend ($100). Retained earnings is reduced by $800 to reflect the market value of the 100 shares distributable, as all dividends come out of retained earnings -- even stock dividends.
Finally, the common stock dividend is paid to shareholders. The shareholders' equity section would change for the last time.
Common stock (par value $1, 1,100 shares outstanding): $1,100
Paid-in capital in excess of par: $700
Total paid-in capital: $1,800
Retained earnings: $1,200
Shareholders' equity: $3,000
Notice the only change here is that the balance sheet now reflects that there are 1,100 shares outstanding after issuing 100 new shares. The common stock account also increases by $100 to reflect the par value for the newly issued shares.
A company pays a stock dividend by increasing its share count. Thus, unlike a cash dividend -- which affects assets and liabilities sections further up in the balance sheet from declaration to payment -- a stock dividend affects only the accounts in the shareholders' equity section. If you're reading this to learn more about stocks, consider opening a brokerage account as the next step in your investing journey.
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