Many large corporations and almost all mutual funds allow their stockholders to reinvest their cash dividends in new shares of stock. These are known as dividend reinvestment plans (DRIP).

As an encouragement and in recognition of the fact that the arrangement allows the corporation to avoid broker fees and other issue costs, the shares are sold to the stockholders at a slight discount below fair value.

Suppose that the Sample Company has such a plan and declares a cash dividend of $10,000,000. The following entry would be recorded on the date of declaration:
Declaration of Cash Dividend Journal Entry
Now suppose that the holders of 10% of the stock decide to have their dividends reinvested in shares with a par value of $12 and a market value (reduced by a discount) of $20.

In this case, on the payment date, only 90% of the dividend would be paid in cash, and 50,000 new shares would be issued ($1,000,000 / $20). The following entry would record the event:
Dividend Payable Journal Entry
While the end result of a reinvestment plan is virtually identical to that achieved by a small stock dividend, the actual chain of events is different. Also, there is no ambiguity as to how it should be accounted for.

If the plan also allows stockholders to supplement their cash dividends with additional sums, the issuance of shares in return for these payments is accounted for in the same way as other newly issued stock.

Frequently Asked Questions

How do dividend reinvestment plans work?

A dividend reinvestment plan (DRP) allows shareholders to automatically reinvest their company's dividends back into the company by buying more shares of stock.

How do you record dividend reinvestment?

When a dividend is reinvested, the company will credit your account with the number of shares you purchase. The journal entry to record this would be a debit to Cash for the amount of the dividend, and a credit to Treasury Stock for the same amount. This would be recorded as an investing activity.

Are reinvested dividends taxed twice?

The payment of dividend income to shareholders is taxed twice because of the transfer of the funds from the firm to the shareholders.

Is DRIP taxed?

Most DRIPs are subject to taxation, which means that you are taxed on the dividends you receive even if you reinvest them in additional stock.

Is DRIP investing worth it?

Investing dividends through a broker or by signing up for DRIP plans directly through the dividend-paying companies can have powerful effects on your investment returns.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.