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Stock Split Accounting

In February 2018, the Board of Directors approved a 2-for-1 split of the company’s common stock in the form of a 100% stock dividend. When the market price per share is too high, investors may lose interest because it is most economical to purchase stock in round lots of 100. A stock price that is too high makes round-lot purchases impossible for some potential investors.

Stock Split and Stock Dividend are two distinct terms that should not be confused. There are several reasons companies consider carrying out a stock split. As the price of a stock gets higher and higher, some investors may feel the price is too high for them to buy, while small investors may feel it is unaffordable. Splitting the stock brings the share price down to a more attractive level.

A journal entry for a small stock dividend transfers the market value of shares issued from retained earnings to paid-in capital. Large stock dividends are defined as those in which the number of new shares issued exceeds 25% of the total number of shares outstanding before the pay-out. In this circumstance, the par value of the shares issued is shifted from retained earnings to paid-in capital. A stock split occurs when a corporation converts its shares into a multiple of its shares. Doing so increases the total number of shares outstanding through an issuance of more shares to existing shareholders. A split is usually authorized in order to alter the price of a company’s stock downward, so that it will be more accessible to retail investors.

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. If a financial statement date intervenes between the declaration and distribution dates, the Stock Dividend Distributable account should be disclosed as part of Paid-In Capital. The choice of one or the other has little impact on the description of the firm’s financial position provided in the balance sheet.

Difference between Stock Dividend and Stock Split

A Stock Split is the division of outstanding shares into several new ones. These new shares are then traded on the same exchange the options industry council oic at current market prices. The split increases the number of shares outstanding, but the company’s overall value does not change.

  • So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it.
  • A large stock dividend (generally over the 20-25% range) is accounted for at par value.
  • In this case, the par value of each share would be increased proportionally so that the total par value of the stock remains the same.
  • A memo entry is normally made to reflect the fact that the split has occurred and that the number of shares and the par value of each share has changed proportionally.

This price decrease is the main reason that a corporation decides to split its stock. A stock split occurs when a company increases the number of outstanding shares with a proportional decrease in the par or stated value. Stock splits are events that increase the number of shares outstanding and reduce the par or stated value per share. For example, a 2-for-1 stock split would double the number of shares outstanding and halve the par value per share. After a 2-for-1 stock split, an individual investor who had owned 1,000 shares might be elated at the prospect of suddenly being the owner of 2,000 shares.

Unit 14: Stockholders’ Equity, Earnings and Dividends

The memorandum entry merely notes for future reference that the number of shares of stock has changed. The current year’s EPS is calculated based on the number of common shares after any stock dividends and splits. To demonstrate the process of accounting for stock splits, suppose that the Moreno Corporation’s stockholders’ equity accounts are as below. Depending on the circumstances, the board of directors of a corporation may wish to take steps that will change the number of outstanding shares of stock without affecting the firm’s assets or liabilities. A company that lacks sufficient cash for a cash dividend may declare a stock dividend to satisfy its shareholders. Note that in the long run it may be more beneficial to the company and the shareholders to reinvest the capital in the business rather than paying a cash dividend.

Ask Any Financial Question

Duratech’s board of directors declares a 5% stock dividend on the last day of the year, and the market value of each share of stock on the same day was $9. Figure 14.9 shows the stockholders’ equity section of Duratech’s balance sheet just prior to the stock declaration. A stock split is a business operation in which a corporation issues extra shares to shareholders, raising the total number of shares by a set ratio based on the shares they previously held. Firms usually split their stock to decrease the market price to a more sensible level for most investors and to increase the liquidity of trading in their shares.

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The benefits of both stock dividends and stock splits are based on the company’s economic forecasts. If the firm is predicted to grow, holding more stock in the company is desirable since an investor can sell the stock at a higher profit in the future. Another reason for a stock split is because a company’s share price has crept higher over time, to the point where it is becoming difficult for an investor to purchase a single share. The concept can also apply to the reverse situation, where a company’s share price has dropped below the minimum allowed price on the stock exchange on which its shares are listed. The company can engage in a reverse split to reduce the number of shares outstanding, thereby increasing the price per share for the remaining shares. The stock split increases the number of shares outstanding and decreases the par value and stock price.

Is it Good to Buy Stock After a Split?

From the investor’s viewpoint, each stockholder receives two additional shares for each share owned. In effect, the old shares are canceled and shares with the new par value are issued. The reasoning behind the approach is that it does not alter the total amount of paid-in-capital or retained earnings and thus more clearly reflects the split nature of the stock dividend. Instead of going through the legal steps required for a split, the board of directors can simply declare a large stock dividend and distribute the shares to the stockholders. While a large stock dividend has the same purpose as a stock split, it is more easily executed than a split when there is a sufficient number of authorized and unissued shares.

This very fact has opened up a wide and relatively new area of financial study called behavioral finance. The disadvantage of a stock split for investors is a greater stock trade fee because brokers often set up a flat fee per round lot (100 shares). That means an investor will pay a lower fee when buying “expensive” shares than “cheap” ones.

None of these reasons or potential effects agree with financial theory. A finance professor will likely tell you that splits are totally irrelevant—yet companies still do it. Splits are a good demonstration of how corporate actions and investor behavior do not always fall in line with financial theory.

Both small and large stock dividends cause an increase in common stock and a decrease to retained earnings. This is a method of capitalizing (increasing stock) a portion of the company’s earnings (retained earnings). After the distribution, the total stockholders’ equity remains the same as it was prior to the distribution.

The reason is that shareholder approval may also be needed, which many organizations consider too difficult to bother with. Investors consider the announcement of a split as a signal that management expects a further increase in the stock price and tries to hold it within an optimal range. Therefore, the stock price will usually increase some time after the announcement.

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