FAR · Select balance sheet accounts · 11 practice questions
Small vs. Large Stock Dividends: Fair Value or Par?
Small stock dividends use declaration-date fair value; large stock dividends use par. Compare one scenario with one fact changed at a time, then practice the entries for size, treasury shares, and declaration timing.
Try one first
Hint
First decide whether the dividend is 'small' or 'large' and then remember whether retained earnings is measured at par value or at market value for that category.
Answer D. This is a small stock dividend (10%), measured at market value. Morrow issues 10,000 shares (100,000 × 10%), so retained earnings is reduced by 10,000 × $20 = $200,000. Common stock is credited for par value (10,000 × $1 = $10,000) and the excess $190,000 is credited to APIC.
Why not A: May lure a candidate who confuses a stock dividend with a stock split (which doesn't reduce retained earnings) or thinks APIC must decrease. It's wrong because a stock dividend (even small) reduces retained earnings and APIC would not decrease in this issuance.
Why not B: Tempting if a candidate misapplies the rule for a large stock dividend (measured at par) or confuses par-only measurement with small dividends. It's wrong because a small dividend is measured at market value, not just par.
Why not C: Attractive if someone mistakenly credits the entire market value to common stock. Incorrect because only par value is credited to common stock; the excess is recorded in APIC.
Same scenario, one fact changes
Base case
Morrow Co. has 110,000 issued shares, including 10,000 treasury shares, at $1 par. On December 1, Year 1, it declares a 10% stock dividend when fair value is $20 per share. Distribution is January 15, Year 2. State law requires increasing legal capital by the new shares' par value. Assume sufficient retained earnings.
Answer: On December 1, Year 1: Debit retained earnings $200,000; credit common stock dividend distributable $10,000; credit additional paid-in capital (APIC) $190,000.
Outstanding shares = 110,000 - 10,000 = 100,000. New shares = 100,000 × 10% = 10,000. This small dividend reduces retained earnings by $200,000 fair value. The credit is split between $10,000 par and $190,000 APIC.
Before you open each one, predict the answer.
Change 1The dividend percentage increases from 10% to 30%.
Answer: On December 1, Year 1: Debit retained earnings $30,000; credit common stock dividend distributable $30,000. APIC is unchanged.
Outstanding shares remain 100,000. A 30% dividend issues 30,000 shares and uses $1 par, not $20 fair value.
Change 2Treasury shares increase from 10,000 to 20,000; issued shares remain 110,000.
Answer: On December 1, Year 1: Debit retained earnings $180,000; credit common stock dividend distributable $9,000; credit APIC $171,000.
Outstanding shares fall to 90,000. The 9,000 new shares have $180,000 fair value and $9,000 par value.
Change 3The declaration date moves to January 1, Year 2.
Answer: No stock dividend entry is required in Year 1. Reduce retained earnings $200,000 on January 1, Year 2.
Declaration controls recognition. Moving declaration into Year 2 moves the retained earnings reduction into Year 2.
Change 4Replace the 10% dividend with a 2-for-1 split effected as a stock dividend; par remains $1.
Answer: On December 1, Year 1: Debit retained earnings $100,000; credit common stock dividend distributable $100,000. APIC is unchanged.
The 100% distribution issues 100,000 shares with par unchanged. Required legal capitalization is $100,000, so use large-dividend accounting despite the split label.
Key points
- Remember: Size picks the price: small uses fair value, large uses par.
- Common stock dividend distributable is equity, not a liability.
- A stock dividend reclassifies equity; total stockholders' equity stays unchanged.
- The record date requires no journal entry.
How the exam traps you
- Applying the dividend percentage to issued shares. Subtract treasury shares first. Only outstanding shares receive the dividend.
- Using par for a small dividend or fair value for a large dividend. Classify the dividend before choosing the measurement basis.
- Waiting until the record or distribution date to reduce retained earnings. Reduce retained earnings at declaration. Distribution only transfers the distributable balance to common stock.
Now the same facts as questions
Each question changes one fact from the one before. Watch which change flips the answer.
Question 1
Answer A. Correct. Issue 10,000 shares; capitalize $200,000 fair value, split between $10,000 par and $190,000 APIC.
Why not B: Incorrect. Par-only measurement applies to a large dividend, not this 10% dividend.
Why not C: Incorrect. The distributable account receives par value only; the excess goes to APIC.
Why not D: Incorrect. This uses all 110,000 issued shares instead of excluding 10,000 treasury shares.
Question 2
Answer C. Correct. The 30,000 new shares are capitalized at $1 par; APIC is unchanged.
Why not A: Incorrect. This applies fair-value measurement to a large stock dividend.
Why not B: Incorrect. A large stock dividend requires an equity reclassification, not merely a memorandum.
Why not D: Incorrect. This applies 30% to issued shares without excluding treasury shares.
Question 3
Answer B. Correct. The 90,000 outstanding shares produce 9,000 new shares at $20 fair value.
Why not A: Incorrect. Treasury shares are excluded, so 110,000 issued shares is not the dividend base.
Why not C: Incorrect. This keeps the original 100,000-share base despite the higher treasury share count.
Why not D: Incorrect. The share count is correct, but a small dividend requires fair-value measurement.
Question 4
Answer D. Correct. Retained earnings decreases at declaration on January 1, Year 2.
Why not A: Incorrect. These amounts belong in Year 2 because declaration occurs in Year 2.
Why not B: Incorrect. Both the recognition year and par-only measurement are wrong.
Why not C: Incorrect. No declaration occurred in Year 1, and this stock dividend does not create a liability.
Question 5
Answer A. Correct. Issue 100,000 new shares and capitalize their $100,000 par value at declaration.
Why not B: Incorrect. A 100% distribution uses large-dividend accounting, not fair-value measurement.
Why not C: Incorrect. The split label does not override unchanged par and the required increase in legal capital.
Why not D: Incorrect. The required capitalization reduces retained earnings, not APIC.
Question 2
| Transaction | Amount |
|---|---|
| March 1, issued 20,000 shares at per share | $5 |
| June 1, repurchased 10,000 shares at per share (treasury, cost method) | $6 |
| Sept 1, reissued 4,000 treasury shares at per share | $8 |
| Dec 1, declared and distributed a 30% stock dividend on outstanding shares (the market price on Dec 1 was per share) | $9 |
Hint
First determine outstanding shares immediately before the stock dividend (exclude treasury shares). Remember that a 30% distribution is a large stock dividend (recorded at par) and that gains on treasury reissuance under the cost method increase APIC, not retained earnings.
Answer A. After the March issuance common stock rises $20,000 and APIC rises $80,000. Treasury repurchase is $60,000; reissuing 4,000 treasury shares at $8 when cost was $6 reduces treasury by $24,000 and credits APIC $8,000. Outstanding shares before the dividend = issued (120,000) − treasury (6,000) = 114,000; a 30% (large) dividend = 34,200 shares recorded at par, so common stock increases $34,200 and retained earnings decreases $34,200. Final balances match option A.
Why not B: Tempting if you apply the 30% dividend to total issued shares (120,000 × 30% = 36,000) instead of to outstanding shares, but treasury shares do not receive the dividend.
Why not C: This treats the 30% distribution as a small stock dividend measured at market ($9) so retained earnings is reduced by fair value and APIC increases by the excess over par; however, 30% is a large dividend and is recorded at par.
Why not D: This reflects incorrectly crediting the $8,000 excess on treasury reissuance to retained earnings instead of to APIC under the cost method; under the cost method the excess is credited to paid-in capital from treasury.
Question 3
Hint
For a small stock dividend, ask two things: what date creates the accounting entry, and is retained earnings measured at par or market value?
Answer B. Retained earnings is reduced on the declaration date for a small stock dividend because the company is committed to issue the shares then. The reduction equals the fair value of shares to be issued: 100,000 × 10% = 10,000 shares × $18 = $180,000. The record and distribution dates identify recipients and complete the equity reclassification but do not change the retained earnings recognition.
Why not A: Tempting because the record date identifies recipients, but no journal entry is made on the record date; the company reduces retained earnings on the declaration date when it commits to the dividend.
Why not C: This mixes up timing and measurement: for a small stock dividend retained earnings is reduced at the shares' fair market value (not par) and on the declaration date, not the distribution date. $10,000 is par-value reclassification (10,000 shares × $1 par), not the retained earnings reduction amount.
Why not D: This uses the correct amount but the wrong date. The distribution (July 1) is when the company issues the shares and reclassifies equity accounts, but the retained earnings reduction occurs on the declaration date.
Question 4
Hint
First decide whether a 10% stock dividend is measured at par or at fair value, then apply that basis only to the shares being distributed.
Answer D. A 10% stock dividend is treated as a small stock dividend and is measured at the fair value of the shares distributed. North distributed 10,000 shares (100,000 × 10%) at $18 per share, so retained earnings is debited for 10,000 × $18 = $180,000.
Why not A: This equals the par value of the shares distributed (10,000 × $5). That treatment would apply to a large stock dividend measured at par, not a small (10%) stock dividend; small stock dividends are measured at fair value.
Why not B: This equals the excess of fair value over par for the shares distributed (10,000 × ($18 − $5)). A candidate might confuse the APIC credit with the retained earnings debit. Retained earnings is debited for the full fair value of the shares for a small stock dividend, not just the excess over par.
Why not C: This incorrectly applies par value to all 100,000 shares outstanding (100,000 × $5) instead of applying any basis only to the shares actually distributed (10% = 10,000 shares). Also, because this is a small stock dividend, the measurement basis is fair value rather than par.
Question 5
Hint
Focus less on the board's label and more on the actual mechanics: Did par value change, and are new shares being issued in a way that requires legal capital to be increased?
Answer A. Although labeled a split, the mechanics show additional shares will be issued while par remains $2, so this is a split effected in the form of a stock dividend. A 2-for-1 (100%) distribution is a large stock dividend and is capitalized at par value. Retained earnings is reduced by 300,000 × $2 = $600,000 on the declaration date and common stock distributable is credited; when shares are issued the distributable is reclassified to common stock.
Why not B: This reflects the small-stock-dividend (measured at market) approach. Because the distribution is 100%, it is a large stock dividend (or split in form of dividend) and is capitalized at par; using the $18 market price would overstate the retained earnings transfer.
Why not C: Tempting because ordinary stock splits are memo-only, but the label cannot override substance. Here new shares are actually issued with par unchanged, requiring capitalization from retained earnings.
Why not D: Appealing to the idea that splits don't reduce retained earnings, but that's only for pure splits that change par. Here shares are issued at unchanged par, so retained earnings must be reduced to increase legal capital; APIC is not the source of that transfer.
Question 6
Hint
First decide whether the dividend is 'small' or 'large' (which determines measurement), then recall when GAAP requires recording the effect on retained earnings (declaration vs. distribution/record date).
Answer A. A 30% stock dividend is considered a large stock dividend and is measured at par value rather than fair value. GAAP requires the reclassification (reduction of retained earnings) to be recorded on the declaration date. Therefore, retained earnings is reduced on Dec 1 by 30,000 × $5 = $150,000 (with common stock distributable credited at par and later reclassified when the shares are issued).
Why not B: This uses the correct par-value measurement for a large dividend but applies it on the distribution date. GAAP requires the retained earnings reduction on the declaration date, not the issuance date.
Why not C: This treats the dividend as a small stock dividend measured at fair value; while the timing is correct (declaration date), a 30% dividend is large and is measured at par, so $600,000 is incorrect.
Why not D: This confuses stock dividends with disclosure-only events or splits. A declared stock dividend requires reclassification and reduction of retained earnings on the declaration date, not mere disclosure until issuance.
Common questions
What is a small vs. large stock dividend under GAAP?
The usual dividing range is 20% to 25% of shares outstanding. A 10% dividend is small and uses declaration-date fair value; a 30% dividend is large and uses par.
When does a stock dividend reduce retained earnings?
Retained earnings decreases on the declaration date. Distribution transfers common stock dividend distributable to common stock without reducing retained earnings again.
Are stock dividends based on issued or outstanding shares?
Use shares outstanding at declaration: issued shares minus treasury shares. Treasury shares do not participate in the dividend.
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