Stock Splits and Stock Dividends

Stock splits

Assume that a board of directors feels it is useful if investors know they can buy 100 shares of the corporation’s stock for less than $5,000. In other words, they prefer to have the price of a share trading between $40 and $50 per share. If the market price of the stock rises to $80 per share, the board of directors can move the market price of the stock back into the range of $40 to $50 per share through a 2-for-1 stock split.

The 2-for-1 stock split will cause the quantity of shares outstanding to double and, in the process, cause the market price to drop from $80 to $40 per share. 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.

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. However, every stockholder’s number of shares has doubled—causing the value of each share to be worth approximately half of what it was before the split. If a corporation had 100,000 shares outstanding, a stockholder who owned 1,000 shares owned 1% of the corporation (1,000 ÷ 100,000). After a 2-for-1 stock split, the same stockholder still owns just 1% of the corporation (2,000 ÷ 200,000). Before the split, 1,000 shares at $80 each totaled $80,000; after the split, 2,000 shares at $40 each still totals $80,000.

A stock split will not change the general ledger account balances and therefore will not change the dollar amounts reported in the stockholders’ equity section of the balance sheet. (Although the number of shares will double, the total dollar amounts will not change.)

Although the 2-for-1 stock split is typical, directors may authorize other stock split ratios, such as a 3-for-2 stock split or a 4-for-1 stock split.

While the general ledger account balances do not change after a stock split, there is one change that should be noted: the par value per share decreases with a stock split. For example, if the par value was $1.00 per share and there were 100,000 shares outstanding, the total par value was $100,000. After a 2-for-1 split, the par value will be $0.50 per share and there are 200,000 shares outstanding with a total par value of $100,000. A memo entry is made to indicate that the split occurred and that the par value per share has changed from $1.00 per share to $0.50 per share.

Stock Dividends

A stock dividend does not involve cash. Rather, it is the distribution of more shares of the corporation’s stock. Perhaps a corporation does not want to part with its cash, but wants to give something to its stockholders. If the board of directors approves a 10% stock dividend, each stockholder will get an additional share of stock for each 10 shares held.

Since every stockholder will receive additional shares, and since the corporation is no better off after the stock dividend, the value of each share should decrease. In other words, since the corporation is the same before and after the stock dividend, the total market value of the corporation remains the same. Because there are 10% more shares outstanding, each share should drop in value.

With each stockholder receiving a percentage of the additional shares and the market value of each share decreasing in value, each stockholder should end up with the same total market value as before the stock dividend. (If this reminds you of a stock split, you are very perceptive. For example, a stockholder owning 100 shares would end up with 150 shares with either a 50% stock dividend or a 3-for-2 stock split. However, there will be a difference in the accounting.)

Even though the total amount of stockholders’ equity remains the same, a stock dividend requires a journal entry to transfer an amount from the retained earnings section to the paid-in capital section. The amount transferred depends on whether the stock dividend is (1) a small stock dividend, or (2) a large stock dividend.

1. Small stock dividend. A stock dividend is considered to be small if the new shares issued are less than 20-25% of the total number of shares outstanding prior to the stock dividend.

   On the declaration date of a small stock dividend, a journal entry is made to transfer the market value of the shares being issued from retained earnings to the paid-in capital section of stockholders’ equity.

   To illustrate, let’s assume a corporation has 2,000 shares of common stock outstanding when it declares a 5% stock dividend. This means that 100 (2,000 shares times 5%) new shares of stock will be issued to the existing stockholders. Assuming the stock has a par value of $0.10 per share and a market value of $12 per share on the declaration date, the following entry is made on the declaration date:

   

   When the 100 shares are distributed to the stockholders, the following journal entry is made:

   

2. Large stock dividend. A stock dividend is considered to be large if the new shares being issued are more than 20-25% of the total number of shares outstanding prior to the stock dividend.

   On the declaration date of a large stock dividend, a journal entry is made to transfer the par value of the shares being issued from retained earnings to the paid-in capital section of stockholders’ equity.

   To illustrate, let’s assume a corporation has 2,000 shares of common stock outstanding when it declares a 50% stock dividend. This means that 1,000 new shares of stock will be issued to the existing stockholders. The stock has a par value of $0.10 per share and the stock has a market value of $12 per share on the declaration date. The following entry should be made on the declaration date:

   

   When the 1,000 shares are distributed to the stockholders, the following journal entry is made: