Stock Splits and Stock Dividends

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. 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. 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. On 31 January 2021, the board of directors proposed a 5-for-4 stock split which was duly approved and new shares were distributed among stockholders.

There is no journal entry recorded; the company createsa list of the stockholders that will receive dividends. Note that dividends are distributed or paid only to shares ofstock that are outstanding. Treasury shares are not outstanding, sono dividends are declared or distributed for these shares.Regardless of the type of dividend, the declaration always causes adecrease in the retained earnings account.

A small stock dividend isviewed by investors as a distribution of the company’s earnings.Both small and large stock dividends cause an increase in commonstock and a decrease to retained earnings. This is a method ofcapitalizing (increasing stock) a portion of the company’s earnings(retained earnings). A small stock dividend occurs when a stockdividend distribution is less than 25% of the total outstandingshares based on the shares outstanding prior to the dividenddistribution. 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.

The 2 for 1 stock split is one of the most common forms of split, however other forms are available. Examples showing the effect on the number of shares for various splits are given below. However, each share is now only worth half the market price it was before the split.

The Nature and Purposes of Dividends

The market value of theoriginal shares plus the newly issued shares is the same as themarket value of the original shares before the stock dividend. Forexample, assume an investor owns 200 shares with a market value of$10 each for a total market value of $2,000. There is no change in total assets, total liabilities, or totalstockholders’ equity when a small stock dividend, a large stockdividend, or a stock split occurs. Both types of stock dividendsimpact the accounts in stockholders’ equity.

The total stockholders’ equity on thecompany’s balance sheet before and after the split remain thesame. A traditional stock split occurs when acompany’s board of directors issue new shares to existingshareholders in place of the old shares by increasing the number ofshares and reducing the par value of each share. For example, in a2-for-1 stock split, two shares of stock are distributed for eachshare held by a shareholder. From a practical perspective,shareholders return the old shares and receive two shares for eachshare they previously owned. The final example above shows a reverse stock split where the number of shares outstanding is reduced rather than increased.

At the time of the split a memo entry would be entered in the records stating that after the 2-for-1 stock split, the corporation has 200,000 shares of $0.25 par value common stock outstanding. The only journal entry needed for a stock split is a memo entry to note that the number of shares has changed and that the par value per share has changed (if the stock has a par value). However, a typical journal entry (one with a debit and a credit) is not needed since the total dollar amounts for the par value and other components of paid-in capital and stockholders’ equity are not changed with a stock split. Similar to distribution of a small dividend, the amounts withinthe accounts are shifted from the earned capital account (RetainedEarnings) to the contributed capital account (Common Stock) thoughin different amounts.

While there has been no disagreement concerning the amount to be used or the account to be credited, accounting practice shows two different accounts being debited. The subsequent distribution will reduce the Common StockDividends Distributable account with a debit and increase theCommon Stock account with a credit for the $9,000. 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.

A reverse split is used when a business wants to increase the market price of its stock. 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. Arnold, a less experienced investor, owns 1,000 shares of Toronto Inc. at $0.5, the total value being $500.

Accounting for Cash Dividends When Only Common Stock Is

For example, if a stock split happens, the prior year’s earnings per share figure should be altered to account for the larger number of shares. In particular, the corporation must obtain a change in the par value (if any) and an increase in the number of authorized shares. Approval must be obtained not only from the state authority but also from the stockholders through a vote. The journal entry to distribute the soft drinks on January 14decreases both the Property Dividends Payable account (debit) andthe Cash account (credit). The declaration to record the property dividend is a decrease(debit) to Retained Earnings for the value of the dividend and anincrease (credit) to Property Dividends Payable for the$210,000.

1. This price decrease is the main reason that a corporation decides to split its stock.
2. All of our content is based on objective analysis, and the opinions are our own.
3. Small increases in the number of shares are accomplished through small stock dividends and are distributed in order to provide stockholders with a symbolic return on their investment that does not require a cash distribution.
4. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
5. 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.

The accounting for a stock dividend is based on the form of the transaction rather than its substance. For this reason, the practice is more complicated compared to the practice used for a split. However, when financial statements are issued, the information regarding the stock split and the new par value per share must be disclosed.

9: Stock Splits

A stock split occurs when a company increases the number of outstanding shares with a proportional decrease in the par or stated value. A stock split usually increases the number of shares of a corporation’s common stock with the intention of reducing the market price of each share of stock. Notice that there is no impact on the total par value of common stock and the total stockholders’ equity of Western Company. These two amounts are the same as they were before the execution of this 5-for-4 stock split. A stock split works much similar to a large scale stock dividend in that the distribution of additional shares under both is usually substantial enough to affect the market price of the stock.

Are there any common methods of accounting for stock splits that I should be aware of?

However, the total dollar value of the shares outstanding does not change. The primary purpose of stock split is to decrease the market price of company’s share so that it becomes more accessible and affordable to potential shareholders and investors. This practice immediately decreases the market price of a company’s stock because the number of shares outstanding are increased without any increase in the value of assets and total stockholders equity. For example, If https://www.quick-bookkeeping.net/periodic-inventory-system-definition/ the current market price of David Inc’s stock is $120 per share, hopefully it will come down to $60 per share immediately after 2-for-1 stock split. A reverse stock split occurs when a companyattempts to increase the market price per share by reducing thenumber of shares of stock. For example, a 1-for-3 stock split iscalled a reverse split since it reduces the number of shares ofstock outstanding by two-thirds and triples the par or stated valueper share.

Stock investors are typically driven by two factors—a desire toearn income in the form of dividends and a desire to benefit fromthe growth in the value of their investment. Members of acorporation’s board of directors understand the need to provideinvestors with a periodic return, and as a result, often declaredividends up free invoice templates to four times per year. However, companies can declaredividends whenever they want and are not limited in the number ofannual declarations. They are not considered expenses, and theyare not reported on the income statement. They are a distributionof the net income of a company and are not a cost of businessoperations.