A stock dividend involves payment of dividends in the form of additional shares of company. That is why it is generally known in India as Bonus shares. Normally, a stock dividend is accompanied some cash dividend.
A stock dividend has three main features (i) the shareholders receive additional share of the company. (ii) the distribution of share is accompanied by a reduction in earned surplus and (iii) the shareholders do not have to pay for the shares received. Thus, stock dividend represents “nothing more than as recapitalization of the company; a stockholder’s proportional ownership remains unchanged”. (Van Horne) It is an official notice to the shareholders that part of the company’s surplus has been permanently committed to the business. To use the accounting term, it is the capitalization of profits and free reserves. It has certain impact on the company and its balance sheet. When a company issues bonus share to its shareholders, accountants make important changes on the books. More specifically, the amount of the stock dividend being paid is subtracted from the surplus (equal to the stock dividend) to represent this shareholders being given share to represent this amount. Not only this, the stock dividend capital, thereby increasing the future dividend liability and cash outlays if the same rate of dividend is to be maintained.