How Stock Dividends Impact Retained Earnings: A Complete Accounting Guide

When a company issues a stock dividend, retained earnings decrease — but not in the way many investors think. Unlike cash dividends that drain company cash, stock dividends trigger an accounting reclassification: retained earnings falls while common stock and capital reserves rise by equal amounts. The bottom line: retained earnings does decrease, yet total shareholders’ equity stays largely unchanged because the reduction is an internal shift within the balance sheet, not a loss of assets or company value.

This guide explains the mechanics of stock dividends, how they affect retained earnings, why the accounting treatment differs for small versus large dividends, and what investors and analysts need to watch. Whether you’re an accountant, investor, or corporate finance professional, you’ll learn the journal entries, balance-sheet effects, per-share impacts, and disclosure requirements that accompany this common corporate action.

Understanding Stock Dividends and Retained Earnings: The Core Relationship

Dividends are distributions by a corporation to its shareholders. The main forms include:

• Cash dividends — direct cash payment; reduces both retained earnings and company cash
• Stock dividends — new shares issued to existing shareholders; reduces retained earnings but not company cash or assets
• Stock splits — change in share count and par value; typically no accounting entry affecting retained earnings
• Other distributions — property or liquidating dividends with special recognition rules

The critical distinction is that cash dividends shrink both assets and retained earnings, whereas stock dividends only reclassify retained earnings into paid-in capital and common stock. No cash leaves the business.

How Are Stock Dividends Measured and Recorded?

Accountants classify stock dividends as small or large because the measurement method—and therefore the impact on retained earnings—differs significantly.

Small stock dividends (typically under 20%–25% of outstanding shares) are measured at fair market value (FMV) at the declaration date. The journal entry debits retained earnings for the full market value and credits common stock at par value, with the excess going to Additional Paid-in Capital (APIC).

Large stock dividends (generally above 20%–25%) are measured at par value (or stated value). The entry debits retained earnings for only the par amount and credits common stock with no APIC adjustment.

Under U.S. GAAP (ASC 505-20) and broadly consistent with IFRS and IAS 33, this distinction recognizes that large issuances are economically closer to stock splits and warrant different accounting. For both types, the key point is: retained earnings decreases by the measured amount, whether that’s FMV or par value.

The Direct Impact on Retained Earnings: Balance Sheet Effect

After a stock dividend is declared and issued:

• Assets: unchanged (no cash paid out)
• Liabilities: unchanged
• Shareholders’ equity: reallocated but total unchanged

More specifically:

This table illustrates the core principle: when retained earnings falls due to a stock dividend, other equity accounts rise by the same total. The company’s net assets and total equity remain unchanged—it’s purely a reallocation within the shareholders’ equity section of the balance sheet.

Why Retained Earnings Decreases: Two Measurement Methods Explained

To see exactly why retained earnings declines, consider two worked examples:

Example 1: Small Stock Dividend at Fair Market Value

• Company A has 100,000 shares outstanding at $1 par value
• Market price at declaration: $20 per share
• Stock dividend declared: 10% (10,000 new shares)
• Total FMV of dividend: 10,000 × $20 = $200,000

Journal entry: