A stock dividend refers to the dividend paid to existing stockholders in the form of additional shares of common stock. Unlike cash dividends it does not result into the cash outflows. The purpose of stock dividend is to conserve cash in the firm, so that it can be used in new projects. It involves simple book keeping transfer from retained earnings to the capital stock account. The stock dividend does not affect the equity position of stockholders; rather it represents a recapitalization of a company which takes place in the form of transfer of certain amount from firm's retained earnings to capital stock account.
Example,
Suppose a firm has following total shareholder's equity account before a 20 percent stock dividend announcement:
A. Common stock (100,000 shares of $ 10 par) .........= $ 1,000,000
B. Additional paid in capital.............................................= $ 200,000
C. Retained earnings........................................................= $ 1,800,000
Total shareholder's equity(A+B+C)..............................= $ 3,000,000
If the firm announces 20% stock dividends, the firm has to issue additional 20,000 shares in common stock. To illustrate the effect of stock dividend on total shareholder's equity accounts, let us assume that current market price of the stock is $ 40. So, amount of stock dividend will be $ 800,000 (i.e. $40 x 20,000 shares). The total amount of dividend is transferred to common stock account and additional paid-in capital from retained earnings. Since par value of common stock is $ 10 a total of $ 200,000 (i.e. $10 x 20,000 shares) is transferred to common stock account and rest $ 600,000 (i.e $ 30 x 20,000 shares) is added to paid-in capital. Thus, the total amount of shareholder's equity remains the same. total shareholder's equity account after 20% stock dividend appears as follows:
A. Common stock( 120,000 Shares of $ 10 par)...............= $1,200,000
B. Additional paid-in capital.................................................= $ 800,000
C. Retained earnings.............................................................= $ 1,000,000
Total shareholder's equity (A+B+C)..................................= $ 3,000,000
Stock dividend generally has no economic significance as it only results into change in capitalization keeping total equity position constant. Stock dividend simply results into an increase in outstanding shares of common stock. In the above example, with a 20% stock dividend, there is an increase in outstanding shares of common stock from 100,000 shares to 120,000 shares.