Davidson Company has 10,000,000 common shares issued and 500,000 shares of treasury stock.The stock's par value is $2 per share and its current market price is $25 per share.Which of the following is correct when a 15% stock dividend is declared and distributed?
A)Retained earnings will decrease $37.5 million.
B)Retained earnings will decrease $35.625 million.
C)Retained earnings will decrease $3 million.
D)Retained earnings will decrease $2.85 million.

Question

Quizplus · Accepted Answer

First, calculate the number of new shares that will be issued: 
10,000,000 x 15% = 1,500,000 new shares

Next, add the new shares to the number of existing shares: 
10,000,000 + 1,500,000 = 11,500,000 total shares

Subtract the treasury stock from the total shares to get the number of outstanding shares: 
11,500,000 - 500,000 = 11,000,000 outstanding shares

The par value of the stock remains the same at $2 per share, so the total par value of the stock is: 
11,000,000 x $2 = $22,000,000

The dividend is paid in stock, so the retained earnings do not decrease. However, the company's additional paid-in capital account will increase. The amount of the increase is equal to the par value of the new shares issued: 
1,500,000 x $2 = $3,000,000

Therefore, the correct answer is B, retained earnings will decrease $35.625 million.

Davidson Company Has 10,000,000 Common Shares Issued and 500,000 Shares