Subsidiary Stock Dividends

A subsidiary may issue stock dividends to convert retained earnings into paid-in capital. The minimum amount to be removed from retained earnings is the par value or stated value of the shares distributed. However, according to accounting principles, when the distribution does not exceed 20% to 25% of the previously outstanding shares, an amount equal to the fair value of the shares should be removed from retained earnings and transferred to paid-in capital. The recording of stock dividends at fair value is defended by the following statement from ARB No. 43:

. . . a stock dividend does not, in fact, give rise to any change whatsoever in either the corporation 's assets or its respective shareholders 'proportionate interests therein. However, it cannot fail to be recognized that, merely as a consequence of the expressed purpose of the transaction and its characterization as a dividend in related notices to shareholders and the public at large, many recipients of stock dividends look upon them as distributions of corporate earnings and usually in an amount equivalent to the fair value of the additional shares received.1

1 Accounting Research and Terminology Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins (New York: American Institute of Certified Public Accountants, 1961), Ch. 7, Sec. B, par. 10.

objective: 1

Explain the effect of subsidiary stock dividends on elimination procedures.

Accounting theory, however, is not consistent when it comes to recording the receipt of dividends by an investor. Even though the false impression of the "typical" investor is sufficient reason to allow the issuing corporation to record the market value of the shares distributed, the investor is not permitted to do likewise. In fact, the investor must not record income when stock dividends are received but must acknowledge the true impact of the transaction, which is that nothing of substance has been given or received. Thus, the investor merely makes a memo entry indicating that the cost of the original investment now is allocated to a greater number of shares. The revised number of shares is important in computing cost per share if there is a subsequent partial sale of the investment.

To review the recording of a stock dividend and to provide a basis for worksheets, assume Company P acquired an 80% interest in Company S on January 1, 20X1, at which time the following determination and distribution of excess schedule was prepared:

Price paid $200,000

Less interest acquired:

Common stock ($10 par) $100,000

Retained earnings 80,000

Total stockholders' equity $180,000

Interest acquired 80% 144,000

On January 2, 20X3, Company S declared and distributed a 10% stock dividend. Prior to declaration of the dividend, its stockholders' equity appeared as follows:

Retained earnings 120,000

Total stockholders' equity $220,000

In the following entry to record the stock dividend, Company S acknowledged the $25 fair value of the 1,000 shares distributed:

Retained Earnings (or Stock Dividends Declared)

Common Stock ($10 par X 1,000 shares) 10,000

Additional Paid-In Capital from Stock Dividend

(1,000 shares X $15 excess over par) 15,000

Parent Using the Simple Equity Method

Continuing the example, on January 1, 20X3, (prior to the dividend) Company P has a simple-equity-adjusted balance of $232,000 in its investment in Company S account, derived as follows:

Original cost $200,000

Share of undistributed income:

Company S retained earnings, January 1, 20X3 $120,000

Company S retained earnings, January 1, 20X1 80,000

Increase in retained earnings $ 40,000

Ownership interest 80% 32,000

Simple-equity-adjusted balance, January 1, 20X3 $232,000

During 20X3, Company S earned $20,000 and made no other dividend declarations. Company P would make the following entries during 20X3, under the simple equity method:

Receipt of stock dividend:

Jan. 2, 20X3 Memo: Investment in Company S now includes 800 added shares for a total of 8,800 shares. The parent's interest remains at 80%.

Recording of equity income:

Dec. 31, 20X3 Investment in Company S

Subsidiary Income

To record the 80% interest in Company S $20,000 reported net income for 20X3.

The partial worksheet below lists the investment in the Company S account at the December 31, 20X3 simple-equity-adjusted cost of $248,000. Note that the partial worksheet includes the redistributed capital structure of Company S which results from the stock dividend. It should be clear that the complications arising from stock dividends pertain primarily to their recording by the separate affiliated firms. There is only a minimal effect on the consolidated worksheet.

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  • Mathias
    Does dividends in subsidiary impact parent retained earnings?
    8 years ago

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