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.
FAQs
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.
How do dividends affect working capital? ›
Since the dividend is typically paid within 12 months, the dividend would be classified as a current liability. As you can see in the visual below, when the company records the dividend, current liabilities increase, which cause net working capital to decrease.
What are the effects of dividends on equity capital? ›
Are Dividends Part of Stockholder Equity? Dividends are not specifically part of stockholder equity, but the payout of cash dividends reduces the amount of stockholder equity on a company's balance sheet. This is so because cash dividends are paid out of retained earnings, which directly reduces stockholder equity.
How does stock dividend affect contributed capital? ›
Stock dividends and stock splits are issued to reduce the market price of capital stock and keep potential investors interested in the possibility of acquiring ownership. A stock dividend is recorded as a reduction in retained earnings and an increase in contributed capital.
Do dividends affect cost of capital? ›
Specifically, dividend increases result in a reduction in the cost of equity capital only when currently experienced ROE < Ke. This is consistent with shareholders preferring earnings to be reinvested by managers to earn a higher rate than their opportunity rate.
What is additional paid in capital? ›
The additional paid-in capital (APIC) represents the excess amount paid in total by investors above the par value of a company's shares. In other words, the additional paid-in capital is the amount that investors are willing to pay over the par value of the company's shares.
Are dividends considered paid in capital? ›
A capital dividend, also called a return of capital, is a payment that a company makes to its investors that is drawn from its paid-in-capital or shareholders' equity. Regular dividends, by contrast, are paid from the company's earnings.
How do dividends paid impact the equity and income statement? ›
If a company pays stock dividends, the dividends reduce the company's retained earnings and increase the common stock account. Stock dividends do not result in asset changes to the balance sheet but rather affect only the equity side by reallocating part of the retained earnings to the common stock account.
What is the relationship between dividends and capital gains? ›
Advisor Insight
A capital gain (or loss) is the difference between your purchase price and the value of the security when you sell it. A dividend is a payout to shareholders from the profits of a company that is authorized and declared by the board of directors.
Can you reduce additional paid-in capital? ›
Additional Paid-In Capital would decrease, if the company buys back the shares at a higher amount than initially sold during IPO. There isn't any change in the APIC when a company's shares are traded on a secondary market.
A capital contribution is returned by a company to its shareholders as a dividend or distribution and they are taxed on the distribution but the shareholder will have had no deduction for the contribution.
Is dividend paid on paid-up capital or face value? ›
The Dividend is always declared on the face value (FV) of the share, regardless of its market value. The dividend rate is calculated as a percentage of the nominal value of the annual share.
Do dividends affect capital losses? ›
capital losses
Capital gains do not include ordinary income, such as interest or dividend income. Although qualified dividends are taxed at long-term capital gains rates under current tax law, you cannot use capital losses to directly offset qualified dividends.
Do dividend distributions affect cost basis? ›
Keep track of stock dividends or non-dividend distributions you receive, because they may affect the cost basis of your shares. If you purchased stock of a company at different times and prices and can adequately identify the shares you sold, their basis is the cost for those specific shares.
Why dividend is not paid out of capital? ›
Any amount not distributed is taken to be re-invested in the business (called retained earnings). The current year profit as well as the retained earnings of previous years are available for distribution; a corporation is usually prohibited from paying a dividend out of its capital.
How do dividends affect the financial statements? ›
If a company pays stock dividends, the dividends reduce the company's retained earnings and increase the common stock account. Stock dividends do not result in asset changes to the balance sheet but rather affect only the equity side by reallocating part of the retained earnings to the common stock account.
How are dividends treated in accounting? ›
If a company pays a dividend by distributing income from current operations, the transaction is recorded as an operating activity on the cash flow statement. On the other hand, if a company pays a dividend from retained earnings, then it is recorded on the balance sheet as both an asset and liability entry.
