Dividends are a common way for companies to pay back some of their capital to shareholders. Consider it kind of like a reward program for investing in the company. These payouts occur regularly each year, whether that's quarterly, monthly, or semi-annually. Dividends can be paid out in different forms—in cash or in-kind in the form of stock. But where does the company get the money for each? Some are debited from a subaccount called the additional paid-in capital. Read on to find out how the company's additional paid-in capital is affected by the issuing of certain dividends.
Key Takeaways
- Additional paid-in capital is an accounting term used to describe the amount an investor pays above the stock's par value.
- Since cash dividends are deducted from a company's retained earnings, there is no effect on the additional paid-in capital.
- The amount equivalent to the value of stock dividends is deducted from retained earnings and capitalized to the paid-in capital account.
What Is Additional Paid-In Capital?
Additional paid-in capital is an accounting term used to describe the amount an investor pays above the stock's par value. The par value, which can be for either common or preferred stock, is the value of the stock as stated in the corporate charter. This value is normally set very low, as shares cannot be sold below the par value. Any money the company collects above the par value is considered additional paid-in capital and is recorded as such on the balance sheet.
The additional paid-in capital is the amount of money investors pay above and beyond the par value of the stock.
When a company agrees to sell shares in an initial public offering (IPO) or a new stock issue, it normally sets the price at the par value. The company may decide to put up a certain amount of shares at a higher price. Whatever the company collects from the sale over and above its par value is put into the company's additional paid-in capital account on the balance sheet. This account is similar to a capital dividend account which is not reported on financial statements.
But how does this affect the company's dividend payouts? Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued—cash or stock.
Impact of a Cash Dividend
A cash dividend is simply a set amount the company pays its shareholders per owned share. As noted above, companies that pay investors dividends as a way to reward them and share the profits. The board of directors normally set out whether the dividend stays the same or changes. For example, a shareholder who owns 50 shares and receives a 50 cent dividend per share receives a total of $25.
If a company decides to issue a cash dividend to its shareholders, the funds are deducted from its retained earnings, and there is no effect on the additional paid-in capital.
Impact of a Stock Dividend
When a company issues a stock dividend, it rewards shareholders with additional shares of stock for each share they already own rather than paying them in cash. Most companies that pay out stock dividends do so if they don't have enough cash reserves to reward their investors. The amount of stock dividends paid out depends on the number of shares an investor owns, where one dividend equals a fraction of a share.
For instance, an investor who owns 100 shares receives a total of 10 additional shares if the issuing company distributes a 10% stock dividend. A stock dividend results in an issuance equal to or less than 25% of outstanding shares.
When a company issues a stock dividend, an amount equivalent to the value of the issued shares is deducted from retained earnings and capitalized to the paid-in capital account. Basically, the common stock and additional paid-in capital sub accounts are increased just as they would be if new shares had been issued, except the increase is funded by the company's own equity rather than by investors.
Example of Additional Paid-In Capital on Stock Dividend
To illustrate, let's take the example of a fictional company called ABC. Assume ABC issues a stock dividend to common stockholders, resulting in a total issuance of 10,000 additional shares. Each share has a par value of $1 and a market price of $15. The total value of the shares, $150,000, is deducted from retained earnings. Of this amount, $10,000 is allocated to the common stock sub account and the remaining $140,000 is allocated to additional paid-in capital.
