Stock Splits and Stock Dividends

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). This procedure is typically used by companies with low share prices that would like to increase their prices. A company may do this if they are afraid their shares are going to be delisted or as a way of gaining more respectability in the market. Many stock exchanges will delist stocks if they fall below a certain price per share. There are several reasons companies consider carrying out a stock split.

None of these reasons or potential effects agree with financial theory. A finance professor will likely tell you that splits are totally irrelevant—yet what is marginal revenue formula to calculate 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.

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• A Stock Split occurs when a company increases the number of outstanding shares with a proportional decrease in the par or stated value.
• For example, assume an investor owns 200 shares with a market value of $10 each for a total market value of $2,000.

The subsequent distribution will reduce the Common Stock Dividends Distributable account with a debit and increase the Common Stock account with a credit for the $9,000. 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. It is important to realize that the market value of the holding has not changed. Historically, buying before the split was a good strategy due to commissions weighted by the number of shares you bought. This isn’t such an advantage today since most brokers offer a flat fee for commissions. This means they charge the same amount whether you trade 10 or 1,000 shares.

Are Stock Splits Good or Bad?

There are plenty of arguments over whether stock splits help or hurt investors. One side says a stock split is a good buying indicator, signaling the company’s share price is increasing and doing well. While this may be true, a stock split simply has no effect on the fundamental value of the stock and poses no real advantage to investors.

Thus, the firm accounts for the dividend at the current market value of the outstanding shares. Stock dividends do not affect the individual stockholder’s percentage of ownership in the corporation. For example, a stockholder who owns 1,000 shares in a corporation having 100,000 shares of stock outstanding, owns 1% of the outstanding shares. After a 10% stock dividend, the stockholder still owns 1% of the outstanding shares—1,100 of the 110,000 outstanding shares.

For example, a 2-for-1 stock split would double the number of shares outstanding and halve the par value per share. Corporations usually account for stock dividends by transferring a sum from retained earnings to permanent paid-in capital. The amount transferred for stock dividends depends on the size of the stock dividend.

Accounting Principles II

Stock investors are typically driven by two factors—a desire to earn income in the form of dividends and a desire to benefit from the growth in the value of their investment. Members of a corporation’s board of directors understand the need to provide investors with a periodic return, and as a result, often declare dividends up to four times per year. However, companies can declare dividends whenever they want and are not limited in the number of annual declarations. They are not considered expenses, and they are not reported on the income statement.

Table of Contents

A larger share issuance is presumed to reduce the market price of shares outstanding, so that share recipients do not experience a net increase in the value of their shares. You have just obtained your MBA and obtained your dream job with a large corporation as a manager trainee in the corporate accounting department. Briefly indicate the accounting entries necessary to recognize the split in the company’s accounting records and the effect the split will have on the company’s balance sheet. After the stock split the number of shares outstanding has doubled to 2,000. If each individual shareholder receives shares pro-rata to their current holding, each shareholder will now hold twice as many shares as before the split. First, a company often decides on a split when the stock price is quite high, making it expensive for investors to acquire a standard board lot of 100 shares.

On the day the board of directors votes to declare a cash dividend, a journal entry is required to record the declaration as a liability. A company’s board of directors has the power to formally vote to declare dividends. The date of declaration is the date on which the dividends become a legal liability, the date on which the board of directors votes to distribute the dividends.

Stock Split

If a balance sheet date intervenes between the declaration and distribution dates, the dividend can be recorded with an adjusting entry or simply disclosed supplementally. Accounting practices are not uniform concerning the actual sequence of entries made to record stock dividends. When an investor shorts a stock, they are borrowing the shares with the agreement that they will return them at some point in the future.

Cash and property dividends become liabilities on the declaration date because they represent a formal obligation to distribute economic resources (assets) to stockholders. On the other hand, stock dividends distribute additional shares of stock, and because stock is part of equity and not an asset, stock dividends do not become liabilities when declared. Similar to distribution of a small dividend, the amounts within the accounts are shifted from the earned capital account (Retained Earnings) to the contributed capital account (Common Stock) though in different amounts. The number of shares outstanding has increased from the 60,000 shares prior to the distribution, to the 78,000 outstanding shares after the distribution.

The percentage of shares issued determines whether a stock dividend is a small stock dividend or a large stock dividend. If a company’s stock has no par value, then no reallocation of funds into the par value account is required. 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. Often, if a company thinks the stock price is too high, it will split the stock to lower the per share price. The total capitalization (value of the shares outstanding) is $200,000 (10,000 x $20).

A traditional stock split occurs when a company’s board of directors issue new shares to existing shareholders in place of the old shares by increasing the number of shares and reducing the par value of each share. For example, in a 2-for-1 stock split, two shares of stock are distributed for each share held by a shareholder. From a practical perspective, shareholders return the old shares and receive two shares for each share they previously owned. The new shares have half the par value of the original shares, but now the shareholder owns twice as many. If a 5-for-1 split occurs, shareholders receive 5 new shares for each of the original shares they owned, and the new par value results in one-fifth of the original par value per share. Arnold, a less experienced investor, owns 1,000 shares of Toronto Inc. at $0.5, the total value being $500.

A stock dividend is a type of dividend distribution in which additional shares are distributed to shareholders, usually at no cost. A Stock Split is the division of outstanding shares into several new ones. These new shares are then traded on the same exchange at current market prices. For example, a 2-for-1 stock split is similar to a 100% stock dividend. In both cases, the number of shares issued and outstanding doubles, and the market price per share will fall accordingly.

Disadvantages of a Stock Split

The answer is not in the financial statement impact, but in the financial markets. Since the same company is now represented by more shares, one would expect the market value per share to suffer a corresponding decline. For example, a stock that is subject to a 3-1 split should see its shares initially cut in third. The benefit to the shareholders comes about, in theory, because the split creates more attractive opportunities for other future investors to ultimately buy into the larger pool of lower priced shares.

The main reason for a stock split is to reduce the market price per share of stock. A stock split can make the shares seem more affordable, even though the underlying value of the company has not changed. All publicly traded companies have a set number of shares that are outstanding.