To illustrate, assume thatDuratech’s board of directors declares a 4-for-1 common stock spliton its $0.50 par value stock. Just before the split, the companyhas 60,000 shares of common stock outstanding, and its stock wasselling at $24 per share. The split causes the number of sharesoutstanding to increase by four times to 240,000 shares (4 ×60,000), and the par value to decline to one-fourth of its originalvalue, to $0.125 per share ($0.50 ÷ 4). A stock split is when a corporation reduces the par value of each share of stock outstanding and issues a proportionate number of additional shares. This does affect the number of shares outstanding and, therefore, the number of shares dividends will be paid on. It also may affect the par value and market price per share, reducing them proportionately.
There are conceptual underpinnings for these differences, but it is primarily related to bookkeeping. The total par value needs to correspond to the number of shares outstanding. Each transaction rearranges existing equity, but does not change the amount of total equity. The answer is not in the financial statement impact, but in the financial markets.
Achieving an increase in the number of shares by a formal stock split necessitates a potentially difficult legal process, primarily because the action requires an amendment of the corporate charter granted by the authorities. Some firms debit the full amount to the Retained Earnings account in order to reflect the fact that the new shares were distributed as a dividend. As a compromise, the action can be described as a stock split effected in the form of a dividend. While a few companies may use a temporary account, DividendsDeclared, rather than Retained Earnings, most companies debitRetained Earnings directly.
So Many Dividends
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- If an individual stockholder owned 10,000 shares or 10% of the 100,000 shares before the stock split, the stockholder will own 30,000 shares or 10% of the 300,000 shares after the stock split.
- When a stock issuance is sufficiently large to be classified as a stock split, the only accounting is to ensure that the legally-required amount of par value has been properly designated as such in the accounting records.
- The number of shares outstanding hasincreased from the 60,000 shares prior to the distribution, to the78,000 outstanding shares after the distribution.
- However, each share is now only worth half the market price it was before the split.
- To illustrate, assume that Duratech Corporation has60,000 shares of $0.50 par value common stock outstanding at theend of its second year of operations.
For example, if a corporation has 100,000 shares outstanding, a 2-for-1 stock split will result in 200,000 shares outstanding. Since the corporation’s assets, liabilities, and total stockholders’ equity are the same as before the stock split, doubling the number of shares should bring the market value per share down to approximately half of its pre-split value. Some companies issue shares of stock as a dividend rather thancash or property. This often occurs when the company hasinsufficient cash but wants to keep its investors happy.
Part 2: Your Current Nest Egg
The number of shares outstanding hasincreased from the 60,000 shares prior to the distribution, to the78,000 outstanding shares after the distribution. The difference isthe 18,000 additional shares in the stock dividend distribution. Nochange to the company’s assets occurred; however, the potentialsubsequent increase in market value of the company’s stock willincrease the investor’s perception of the value of the company. A large stock dividend occurs when adistribution of stock to existing shareholders is greater than 25%of the total outstanding shares just before the distribution. Theaccounting for large stock dividends differs from that of smallstock dividends because a large dividend impacts the stock’s marketvalue per share.
This is the date that dividend payments are prepared andsent to shareholders who owned stock on the date of record. Therelated journal entry is a fulfillment of the obligationestablished on the declaration date; it reduces the Cash DividendsPayable account (with a debit) and the Cash account (with acredit). There are two methods that are commonly used in accounting for Stock Splits. As a result, the corporation reduces the par value of its stock from $15 to $5 and increases the number of shares issued and outstanding from 50,000 to 150,000. The end result is a doubling, tripling, or quadrupling of the number of outstanding shares and a corresponding decrease in the market price per share of the stock.
However, if this event is a stock dividend, the stock’s par or stated value will not change, but Retained Earnings will decrease and Common Stock will increase. When a significant increase in shares is accomplished closing entries are dated in the journal as of the date they are actually journalized by declaring a large stock dividend, this may be described as a split instead of a dividend. Disclosures related to prior years should be restated retroactively to include the effects of the split.
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Ifyou buy a candy bar for $1 and cut it in half, each half is nowworth $0.50. The total value of the candy does not increase justbecause there are more pieces. The journal entry to record the declaration of the cashdividends involves a decrease (debit) to Retained Earnings (astockholders’ equity account) and an increase (credit) to CashDividends Payable (a liability account). It may seem odd that rules require different treatments for stock splits, small stock dividends, and large stock dividends.
Are there any drawbacks to a stock split?
They both serve to reduce the market price per share and increase the number of shares issued and outstanding. While the companies practically have a very little to no direct control over their stock prices, the desired result of a reverse split is often the increased market price of their common stock. A common factor that drives companies to consider for a reverse stock split is to maintain the minimum share price set by the stock exchange in which they are listed so as to protect themselves from being delisted from the exchange. In both cases, the number of shares issued and outstanding doubles, and the market price per share will fall accordingly.
Example: Disclosure of Stock Split
For an individual shareholder, the total market value of their holding also remains the same. For example, if before the split a shareholder owned 50 shares, then the total market value is calculated as follows. Often, if a company thinks the stock price is too high, it will split the stock to lower the per share price. Because the price of the firm’s stock is likely to fall to $30, the total market value of each stockholder’s investment immediately after the split will be about the same as it was before the split. When state law requires a transfer, under the circumstances of a split effected as a dividend there is no need to capitalize retained earnings, other than to the extent occasioned by legal requirements.
