On January 31, 2009, Village Bank had 500,000 shares of $2 par value ordinary share outstanding. On that date, the company declared a 14% stock dividend when the market price of the share was $37 per share. The immediate effect of this dividend upon Village Bank was:

Question

Quizplus · Accepted Answer

A stock dividend is a distribution of additional shares of stock, rather than cash. Therefore, there is no reduction in cash. The declaration of a stock dividend does not create a liability to the shareholders. Instead, it reduces retained earnings, since the company is transferring a portion of its earnings to additional shares of stock. The amount of the reduction in retained earnings is the par value of the additional shares issued (in this case, 14% of 500,000 shares, or 70,000 shares, at a par value of $2 per share, for a total of $140,000). Therefore, the correct answer is that the immediate effect of the stock dividend was a reduction in retained earnings of $2,590,000.

On January 31, 2009, Village Bank Had 500,000 Shares of $2