4.4 Dividends

A dividend is a payment, either in cash, other assets (in kind), or stock, from a reporting entity to its shareholders. Figure FG 4-2 provides definitions for some of the terms used in connections with dividends.

Retained earnings of a personal holding company, which, although not distributed to shareholders, are reported by the shareholders for federal income tax purposes as an ordinary dividend. The tax basis of the stock is increased by the amount of the consent dividend

Preferred dividend that must be declared and paid for all periods, before any dividend may be declared and paid to common shareholders

A transaction that does not necessarily have the characteristics generally associated with a dividend, but nevertheless results in a transfer of value to the holder of an equity instrument that requires accounting similar to a dividend (e.g., accretion to redemption value on redeemable convertible preferred stock)

Amounts paid to holders of unissued shares (e.g., unvested stock or options) in a stock compensation plan

Term indicating that the quoted price of a share of stock excludes the value of a declared dividend; the term attaches from the record date, or a few days before the record date (to allow for the recording of transfers just prior to the record date), until the payment date

Preferred dividend to which the preferred shareholders lose their rights if the dividend is not declared in respect of the applicable period

Preferred dividend that never exceeds a specified rate regardless of the dividends paid to common shareholders

Pro rata distribution to shareholders of cash, other assets (including evidences of indebtedness), or shares of capital stock declared by the board of directors

Dividend paid in the form of additional shares of stock having a value equal to the specified dividend rate

Preferred dividend in excess of a stipulated minimum rate, shared with the common shareholders (the preferred shareholders participate in the earnings of the entity) usually after the dividends paid to the common shareholders reach a prescribed amount per share. Fully participating dividends are shared, after the prescribed minimums, without limitation; partially participating dividends are shared only to a specified maximum amount per share

Dividend on preferred stock usually at a specified rate stated in dollars per share or as a percentage of par value, payable at stated intervals, usually quarterly

Date at which shareholders registered in the stock records will share in the dividend payment. This date is usually between the declaration date and payment date

A dividend paid in the form of promissory notes that may be negotiable, bear interest, and mature at different dates, and that is usually payable in cash

Pro rata distribution by a reporting entity of shares of a subsidiary without the surrender of the shares in the distributing reporting entity

Distribution by a reporting entity of shares of a subsidiary in exchange for a portion of the shares in the distributing reporting entity

Distribution by a reporting entity of shares of a subsidiary and new shares of its own stock in exchange for all of the old shares of the distributing reporting entity

Issuance of additional shares of stock at a fixed ratio in relation to current shares to present shareholders. See FG 4.4.4 for information on the distinction between stock dividends and stock splits

Date at which shareholders registered in the stock records will share in the dividend payment. This date is usually between the declaration date and payment date

4.4.1 Declaring a dividend

Generally, a reporting entity’s board of directors decides when, in what amount, and in what form of consideration dividends are to be paid. When making decisions about a dividend payment, the board considers a number of factors, including the following.

• The legality of the dividend in relation to the reporting entity’s articles of incorporation and relevant state (or other jurisdiction) law

Statutory restrictions may limit the timing and amount of dividends that can be declared to shareholders. Typically, a reporting entity is subject to the laws of the state in which it is incorporated. The diversity of dividend statutes across jurisdictions makes it impracticable to state a general rule on the amounts available for dividends. However, a common restriction is that dividends may not be paid if doing so would render the reporting entity insolvent. For solvent reporting entities, payment of dividends from retained earnings is almost always permissible. In the US, state law typically governs corporate activities, including the payment of dividends. Some states allow dividends to be paid from current earnings despite an accumulated deficit from past operations; these are sometimes referred to as nimble dividends. In some circumstances, dividends may be paid from capital surplus or an appraisal surplus. Outside the US, dividend restrictions may be more onerous and, in many cases, may also require shareholder approval before they can be declared and paid.

4.4.2 Recording a dividend

A dividend should be recorded when it is declared and notice has been given to the shareholders, regardless of the date of record or date of settlement. As a practical matter, the dividend amount is not determinable until the record date. To record a dividend, a reporting entity should debit retained earnings (or any other appropriate capital account from which the dividend will be paid) and credit dividends payable on the declaration date.

If the declared dividend is greater than retained earnings, we believe that an SEC registrant should analogize to SAB Topic 3.C and record any excess of the dividend above retained earnings against additional paid-in capital. Any declared dividend amounts remaining after debiting retained earnings and additional paid-in capital should be booked to accumulated deficit. As indicated in FG 4.4.1, the entity’s board of directors (or the parties responsible for declaring dividends) will have to consider the legality of declaring a dividend that would result in an accumulated deficit prior to declaring the dividend in question.

4.4.3 Dividend in kind

A dividend in kind is paid by distributing property of the reporting entity, so is considered a nonmonetary transaction. As such, it should be recorded using the guidance in ASC 845, Nonmonetary Transactions. As discussed in ASC 845-10-30-10, when a reporting entity distributes its property (other than in a spinoff transaction) in a pro rata dividend to all shareholders, the amount of the dividend should be recorded at the fair value of the property distributed. On the declaration date, a reporting entity would record a dividend payable for the fair value of the assets. A gain or loss should be recognized for the difference between the fair value and carrying value of the property distributed on the date of disposition of the asset and settlement of the liability, as described in ASC 845-10-30-1.

If a reporting entity distributes shares of a consolidated entity or equity method investee as a dividend, it should be valued based on the recorded amount of the nonmonetary assets distributed based on the guidance in ASC 845-10-30-10.

Accounting for the distribution of nonmonetary assets to owners of an entity in a spinoff or other form of reorganization or liquidation or in a plan that is in substance the rescission of a prior business combination shall be based on the recorded amount (after reduction, if appropriate, for an indicated impairment of value) (see paragraph 360-10-40-4) of the nonmonetary assets distributed… A pro rata distribution to owners of an entity of shares of a subsidiary or other investee entity that has been or is being consolidated or that has been or is being accounted for under the equity method is to be considered to be equivalent to a spinoff. Other nonreciprocal transfers of nonmonetary assets to owners shall be accounted for at fair value if the fair value of the nonmonetary asset distributed is objectively measurable and would be clearly realizable to the distributing entity in an outright sale at or near the time of the distribution.

If part of the shares of an investee accounted for under the equity method are distributed as a dividend in kind and part are concurrently sold by the investor on the open market, accounting for the dividend in kind at the recorded amount may not be appropriate.

4.4.4 Stock dividends and stock splits

A stock dividend is a dividend paid in shares, generally issued to provide common shareholders with a portion of their respective interest in retained earnings without distributing cash from the business. A stock split is the issuance of common shares to existing shareholders for the purpose of reducing the per share market price. Lowering the per share price increases their marketability to a wider population of investors without diluting the ownership interests of the existing common shareholders.

In both a stock dividend and a stock split, a reporting entity issues shares to its existing shareholders in proportion to their ownership interest. Generally, a stock dividend is a smaller distribution than a stock split, but whether an issuance of shares is a stock dividend or stock split is not always clear. Both the AICPA and the New York Stock Exchange (NYSE) have indicated that when an issuance of shares is so small in comparison with the shares previously outstanding that it has no apparent effect upon the share market price, there is a presumption that a stock dividend was declared. Similarly, when the number of additional shares issued is so great that it has, or may reasonably be expected to have, the effect of materially reducing the share price, the transaction should be treated as a stock split.

ASC 505-20-25-3 through ASC 505-20-25-6 and the NYSE have established rules of thumb as to what constitutes a “small” distribution that should be treated as a stock dividend and a “large” distribution that should be treated as a stock split. The SEC’s interpretation in this area is discussed in SEC FRP 214, Pro Rata Stock Distributions to Shareholders. Figure FG 4-3 summarizes this guidance.

Distributions of new shares that are less than 20-25% of those previously outstanding or that recur frequently are to be treated as stock dividends even if management representations to shareholders that it is a stock split

Distributions greater than 25% but less than 100% of the number of shares outstanding prior to the distribution are treated as a stock dividend when the distributions assume the character of stock dividends through repetition of issuance under circumstances not consistent with the true intent and purpose of a stock split

Distributions of over 25% may be accounted for as a stock dividend if they are part of a program of recurring distributions and accounting for them as a stock split would be misleading

Although ASC 505-20-25 uses a different threshold than the NYSE, a reporting entity listed on the NYSE would generally treat a distribution of greater than 25% of the shares outstanding as a stock split.

When a stock dividend in form is determined to be a split in substance, ASC 505-20-50-1 recommends that every effort be made to avoid the use of the word dividend in related corporate resolutions, notices, and announcements and that, in those cases where because of legal requirements this cannot be done, the transaction be described, for example, as a stock split effected in the form of a dividend.

ASC 260-10-55-12 requires that computations of earnings per share give retroactive recognition to a change in capital structure occurring during the period (or after the close of the period but before the financial statements are available to be issued) for all periods presented. See FSP 5.12 for balance sheet reporting and FSP 7.6.1 for earnings per share considerations related to stock dividends and stock splits.

4.4.4.1 Accounting for a stock dividend

A stock dividend is recorded by transferring the fair value of the shares issued from retained earnings to the related equity accounts as discussed in ASC 505-20-30-3. Retained earnings is charged (debited) for the fair value of the shares, and capital stock (for the par value of the shares) and additional paid-in capital are credited. In those rare instances when the par value of the shares exceeds the fair value of the shares distributed, retained earnings should still be charged for the fair value of the shares, capital stock is credited for the par value of the stock, and additional paid-in capital is charged (debited) for the difference between fair value and par value. If there is no or insufficient paid-in capital, or if the directors vote to charge retained earnings for par value despite the existence of additional paid-in capital, it is acceptable to charge retained earnings.

In the case of stock dividends declared by closely held reporting entities, ASC 505-20-30-5 states that there is no need to capitalize retained earnings other than to meet legal requirements. The reason for this exception to the general rule is that it is presumed that, because of their intimate knowledge of the reporting entity’s affairs, shareholders understand the amount of available earnings for dividends. What constitutes a closely held reporting entity for this purpose depends on the circumstances in each case.

Issuance costs incurred in connection with stock dividends should be expensed as incurred. This differs from issuance costs incurred for sales of stock, which are typically recorded as a reduction of the sales proceeds.

FG Corp has 1 million common shares outstanding. The shares have a $1 par value per share. FG Corp declares a 10% stock dividend and, as a result, issues 100,000 additional shares to current stockholders. FG Corp’s common stock price is $5 per share on the declaration date.

A reporting entity may issue a dividend to its shareholders and give the shareholders the choice of receiving the dividend in either cash or shares (referred to as an optional dividend). Consistent with the accounting for stock dividends, retained earnings should be charged for an amount equal to the fair value of the shares distributed. When shareholders have the option to elect cash or stock, the number of shares to be issued is a variable number. The amount of retained earnings capitalized for the entire distribution should be equal to the amount of the dividend had it been paid entirely in cash. It is rare that the fair value of the stock dividend would be less than the cash dividend; therefore, the cash dividend should be indicative of the minimum fair value of the shares issued.

There is no specific guidance on the accounting for a stock dividend when a reporting entity has an accumulated deficit rather than retained earnings. The SEC staff has historically taken the view that in this circumstance, the reporting entity should capitalize only the stock’s par value from additional paid-in capital.

If a common stock dividend is paid to holders of preferred stock when there is an accumulated deficit, the dividend should be accounted for at fair value with a corresponding increase in loss applicable to common shareholders. Fair value accounting is also appropriate for dividends declared on preferred stock that are payable in the form of additional preferred shares, when payment in additional preferred shares is at the discretion of the issuer. We believe the fair value charge for stock dividends declared on preferred stock should be recorded as a charge to additional paid-in capital when a retained earnings deficit exists by analogy to ASC 480-10-S99-2 (SAB Topic 3.C, Redeemable Preferred Stock). That guidance indicates that amortization of a discount to the redemption amount of preferred stock should be charged to additional paid-in capital in the absence of retained earnings.

Stock dividends almost always create fractional shares. A reporting entity may address this by selling the fractional shares and distributing cash to shareholders, by issuing special certificates (called a scrip issue) for the fractional shares which are then bought and sold through an agent, by arranging for shareholders to buy or sell fractional shares without a scrip issue, or by issuing fractional share certificates.

Each method of handling fractional shares is accounted for in the same manner as whole shares issued as a stock dividend.

Stock dividends issued from a subsidiary to its parent normally result in a memorandum entry by the parent for the additional shares received. Although the subsidiary may capitalize retained earnings in connection with the stock dividend, ASC 810-10-45-9 states that consolidated retained earnings need not be capitalized.