A company declares a 40% stock dividend when there were 4 million common shares outstanding with a $1 par value. The current market price is $20 per common share. Which of the following will be the effect of the stock dividend?

A. Retained earnings will decrease by $1.6 million and contributed capital will increase by $1.6 million.

B. Contributed capital will decrease by $1.6 million and retained earnings will increase by $1.6 million.

C. Retained earnings will decrease by $32 million and contributed capital will increase by $32 million.

D. Contributed capital will decrease by $32 million and retained earnings will increase by $32 million.

Stock dividend is the payment of dividends to stockholders in the form of stock/shares of the company. Stock is issued at the market price and the value of the dividend is transferred from the retained earnings to the add-in-capital accounts.

Stock Dividend Value = Numbers of outstanding shares x Stock dividend ratio x Market value of a share

Stock Dividend Value = 4 million x 40% x $20 = $32 million

Now the balance of $32 million will be transferred from retained earning to Contributed capital account