Do Stock Dividends Affect the Retained Earnings Account? (2024)

FAQs

Do Stock Dividends Affect the Retained Earnings Account? ›

If a company pays stock dividends, the dividends reduce the company's retained earnings and increase the common stock account. Stock dividends do not result in asset changes to the balance sheet but rather affect only the equity side by reallocating part of the retained earnings to the common stock account.

Introduction to retained earnings

Retained earnings are the portion of profits that a company maintains rather than paying out to shareholders as dividends. The greater the portion of profit that a company pays out as dividends, the lower its retained earnings will be, and vice versa.

A stock split does not affect the total value of a company, so it does not impact the total retained earnings. However, a stock split can impact the per-share earnings, which is an essential metric for investors to evaluate the financial health of a company.

Retained Earnings are listed on a balance sheet under the shareholder's equity section at the end of each accounting period. To calculate Retained Earnings, the beginning Retained Earnings balance is added to the net income or loss and then dividend payouts are subtracted.

When a company issues common stock to raise capital, the proceeds from the sale of that stock become part of its total shareholders' equity but do not affect retained earnings. However, common stock can impact a company's retained earnings any time dividends are issued to stockholders.

First, for a dividend to be paid, there must be profits. A general law principle states that dividends can only be paid out of retained profits. In itself, this is a rather simple test to apply.

Negative retained earnings can also limit a company's ability to pay dividends to shareholders or make investments in the business.

Retained earnings are affected by any increases or decreases in net income and dividends paid to shareholders. As a result, any items that drive net income higher or push it lower will ultimately affect retained earnings.

Stock dividends have no effect on the total amount of stockholders' equity or on net assets. They merely decrease retained earnings and increase paid-in capital by an equal amount. Immediately after the distribution of a stock dividend, each share of similar stock has a lower book value per share.

For example, a 2-for-1 stock split is similar to a 100% stock dividend. In both cases, the number of shares issued and outstanding doubles, and the market price per share will fall accordingly.

Do you deduct dividends from retained earnings? ›

Dividends are distributions to owners or stockholders. They may be paid in cash, stock, or as dividends in kind. See FG 4.4 for accounting for dividends. Cash dividends declared are generally reported as a deduction from retained earnings.

Close dividend accounts

If you paid out dividends during the accounting period, you must close your dividend account. Now that the income summary account is closed, you can close your dividend account directly with your retained earnings account. Debit your retained earnings account and credit your dividends expense.

On the initial date when a dividend to shareholders is formally declared, the company's retained earnings account is debited for the dividend amount while the dividends payable account is credited by the same amount. Retained Earnings → Debited [Dr.] Dividends Payable → Credited [Cr.]

If a company pays stock dividends, the dividends reduce the company's retained earnings and increase the common stock account. Stock dividends do not result in asset changes to the balance sheet but rather affect only the equity side by reallocating part of the retained earnings to the common stock account.

A stock split does not impact the Retained Earnings account.

Are Dividends Part of Stockholder Equity? Dividends are not specifically part of stockholder equity, but the payout of cash dividends reduces the amount of stockholder equity on a company's balance sheet.

Dividends are payments which a company makes to its shareholders out of its profits. These profits are essentially what is left over in the business once all taxes, expenses and liabilities have been paid. Also called 'retained profit', this left over money may accumulate over time.

Dividends represent a portion of a company's net income. However, dividends don't cause net income to go down. Rather, dividends are just one example of what a company might choose to do with its net income.