Stock-Splits-and-Stock-Dividends

StockSplitsandStockDividendsStocksplitsLet'ssaythataboardofdirectorsfeelsitisusefultothecorporationifinvestorsknowtheycanbuy100sharesofstockforunder$5,000.Thismeansthatthedirectorswillworktokeepthesellingpriceofasharebetween$40and$50pershare.Ifthemarketpriceofthestockrisesto$80pershare,theboardofdirectorscanmovethemarketpriceofthestockbackintotherangeof$40to$50persharebyapprovinga2-for-1stocksplit.Suchanactionwillcausethetotalnumberofsharesoutstandingtodoubleand,intheprocess,causethemarketpricetodropfrom$80downto$40pershare.Forexample,ifacorporationhas100,000sharesoutstanding,a2-for-1stocksplitwillresultin200,000sharesoutstanding.Sincethecorporation'sassets,liabilities,andtotalstockholders'equityarethesameasbeforethestocksplit,doublingthenumberofsharesshouldbringthemarketvaluepersharedowntoapproximatelyhalfofitspre-splitvalue.Aftera2-for-1stocksplit,anindividualinvestorwhohadowned1,000sharesmightbeelatedattheprospectofsuddenlybeingtheownerof2,000shares.However,everystockholder'snumberofshareshasdoubled—causingthevalueofeachsharetobeworthonlyhalfofwhatitwasbeforethesplit.Forexample,ifacorporationhad100,000sharesoutstanding,astockholderwhoowned1,000sharesowned1%ofthecorporation(1,000÷100,000).Aftera2-for-1stocksplit,thesamestockholderstillownsjust1%ofthecorporation(2,000÷200,000).Beforethesplit,1,000sharesat$80eachtotaled$80,000;afterthesplit,2,000sharesat$40eachstilltotals$80,000.Astocksplitwillnotchangethegeneralledgeraccountbalancesandthereforewillnotchangethedollaramountsreportedinthestockholders'equitysectionofthebalancesheet.(Althoughthenumberofshareswilldouble,thetotaldollaramountswillnotchange.)Althoughthe2-for-1stocksplitistypical,directorsmayauthorizeotherstocksplitratios,suchasa3-for-2stocksplitora4-for-1stocksplit.Whileaccountbalancesdonotchangeafterastocksplit,thereisonechangethatshouldbenoted:theparvaluepersharedecreaseswithastocksplit.Eventhoughtherearemoresharesofstock,thetotalparvalueisunchanged.Forexample,iftheparvalueis$1.00pershareandthereare100,000sharesoutstanding,thetotalparvalueis$100,000.Aftera2-for-1split,theparvalueis$0.50pershareandthereare200,000sharesoutstandingforatotalparvalueof$100,000.Notethatthetotalparvalueremainedatthesameamount.Amemoentryismadetoindicatethatthesplitoccurredandthattheparvaluepersharehaschanged.StockDividendsAstockdividenddoesnotinvolvecash.Rather,itisthedistributionofmoresharesofthecorporation'sstock.Perhapsacorporationdoesnotwanttopartwithitscash,butwantstogivesomethingtoitsstockholders.Iftheboardofdirectorsapprovesa10%stockdividend,eachstockholderwillgetanadditionalshareforeach10sharesheld.Sinceeverystockholderreceivedadditionalshares,andsincethecorporationisnobetteroffafterthestockdividend,thevalueofeachshareshoulddecrease.Inotherwords,sincethecorporationisthesamebeforeandafterthestockdividend,thetotalmarketvalueofthecorporationremainsthesame.Becausethereare10%moresharesoutstanding,however,eachshareshoulddropinvalue.Witheachstockholderreceivingapercentageoftheadditionalsharesandthemarketvalueofeachsharedecreasinginvalue,eachstockholdershouldendupwiththesametotalmarketvalueasbeforethestockdividend.(Ifthisremindsyouofastocksplit,youareveryperceptive.Astockholderof100shareswouldendupwith150shareswhetheritwerea50%stockdividendora3-for-2stocksplit.However,therewillbeadifferenceintheaccounting.)Eventhoughthetotalamountofstockholders'equityremainsthesame,astockdividendrequiresajournalentrytotransferanamountfromtheretainedearningssectionofthebalancesheettothepaid-incapitalsectionofthebalancesheet.Theamounttransferreddependsonwhetherthestockdividendis(1)asmallstockdividend,or(2)alargestockdividend.1.Smallstockdividend.Astockdividendisconsideredtobesmallifthenewsharesbeingissuedarelessthan20-25%ofthetotalnumberofsharesoutstandingpriortothestockdividend.Onthedeclarationdateofasmallstockdividend,ajournalentryismadetotransferthemarketvalueofthesharesbeingissuedfromretainedearningstothepaid-incapitalsectionofstockholders'equity.Toillustrate,let'sassumeacorporationhas2,000sharesofcommonstockoutstandingwhenitdeclaresa5%stockdividend.Thismeansthat100(2,000sharestimes5%)newsharesofstockwillbeissuedtoexistingstockholders.Assumingthestockhasaparvalueof$0.10pershareandamarketvalueof$12pershareonthedeclarationdate,thefollowingentryismadeonthedeclarationdate:RetainedEarnings(100sharesX$12)1,200CommonStockDividendDistributable10Paid-inCapitalinExcessofPar1,190Whenthe100sharesaredistributedtothestockholders,thefollowingjournalentryismade:CommonStockDividendDistributable10CommonStock102.Largestockdividend.Astockdividendisconsideredtobelargeifthenewsharesbeingissuedaremorethan20-25%ofthetotalvalueofsharesoutstandingpriortothestockdividend.Onthedeclarationdateofalargestockdividend,ajournalentryismadetotransfertheparvalueofthesharesbeingissuedfromretainedearningstothepaid-incapitalsectionofstockholders'equity.Toillustrate,let'sassumeacorporationhas2,000sharesofcommonstockoutstandingwhenitdeclaresa50%stockdividend.Thismeansthat1,000newsharesofstockwillbeissuedtoexistingstockholders.