East Corp., a calendar-year company, had sufficient retained earnings in 20X3 as a basis for dividends, but was temporarily short of cash. East declared a dividend of $100,000 on April 1, 20X3, and issued promissory notes to its stockholders in lieu of cash. The notes, which were dated April 1, 20X3, had a maturity date of March 31, 20X4, and a 10% interest rate. How should East account for the scrip dividend and related interest?
When a scrip dividend is declared on April 1, 20X3, a liability is recognized for the scrip dividend payable by debiting retained earnings for the $100,000 face amount of promissory notes. When a liability is accrued, for which interest is payable, the interest accrued till the year end has to be recognized on December 31, 20X3 (from April 1 to December 31), that is 9 months = $100,000 x 10% x 9 / 12 = $7,500. The interest from January 1 to March 31. 20X4, will be recognized on March 31, 20X4 when the notes are due.