How should stock dividends be measured and accounted for? Is this treatment justified?

Question

What will be an ideal response?

Answer 1

ANSWER:
ARB 3 discusses two separate accounting policies for stock dividends, depending on the size of the dividend. Large stock dividends are defined as those over 25 percent and are accounted for by reclassifying retained earnings to contributed capital based on the par value of the stock issued. Small stock dividends are defined as those less than 20 percent and are accounted for by reclassifying retained earnings to contributed capital on the basis of the market value of the stock and using predividend market prices to value the dividend. Either method could be used from 20 percent to 25 percent. ASR No. 124 of the SEC sharpened the cutoff between small and large stock dividends to 25 percent to eliminate the “no man’s land” where either method could be used.

The contention has been made that the accounting for stock dividends arrived at by the CAP is really a matter of management intent—whether management desires to give shareholders evidence of their interest in retained earnings or desires to lower the price of the shares with the stock dividend serving as a stock split but without changing par value of the stock. However, even if this contention is correct, allowing accounting to be a matter of managerial intent would allow similar transactions to be booked differently, an example of the flexibility problem. Also, stock dividends are not distributions of real wealth.

Some attempts have been made to use the size of the dividend to define relevant circumstances. However, because total market value of outstanding stock should not change because of stock dividends, little support can be given to using the predividend market price per share to value the transaction. There does not appear to be a relevant circumstance justifying two accounting methods.