14 3: Stock Dividends and Splits Business LibreTexts

This type of split is often employed by companies to make their stock more affordable and attractive to a broader range of investors. It does not alter the company’s market capitalization or the value of individual holdings, but it can enhance liquidity and marketability. Companies like Apple and Tesla have famously executed forward stock splits to maintain an accessible share price for retail investors. No, a stock split does not require a journal entry because it does not affect the total stockholders’ equity, retained earnings, or paid-in capital. The only changes are in the number of shares outstanding, the par value per share, and the market price per share.

• To see the effects on the balance sheet, it is helpful tocompare the stockholders’ equity section of the balance sheetbefore and after the small stock dividend.
• However, companies can declare dividends whenever they want and are not limited in the number of annual declarations.
• The first obvious implication to remember is that while stock splits may generate short-term price movements, they do not change a company’s underlying value or an investor’s percentage ownership.
• It’s crucial to understand that, from an accounting standpoint, a stock split is a purely cosmetic change.

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

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. 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. If so, the company would be more profitable and the shareholders would be rewarded with a higher stock price in the future. 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.

Differences Between Stock Splits and Stock Dividends

I made this up because I think it makes it easier to do these problems. So the split ratio would be 2 for 1, 2 divided by 1, it’s going to equal 2. All we’re doing is we’re changing the market price, the par value, and the shares outstanding.

12 Stock dividends and splits

Another way of saying this is that, on average, following a stock split announcement, the stock to be split tends to be overpriced relative to its fundamental value. This phenomenon, known as the “announcement premium,” has been studied by financial researchers for decades. A split ratio, expressed as X for Y (e.g., 2-for-1), indicates how many new shares each existing share will be divided into. It is used to calculate the new number of shares, par value, and market price. For example, in a 2-for-1 split, the split ratio is 2, meaning each share splits into two.

Journal entry for reverse stock split

In a 2-for-1 split, for example, the value per share typically will be reduced by half. As such, although the number of outstanding shares and the price change, the total market value remains constant. If you buy a candy bar for $1 and cut it in half, each half is now worth $0.50. The total value of the candy does not increase just because there are more pieces. 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.

Journal Entries for Forward Splits

To illustrate, assume that Duratech Corporation has 60,000 shares of $0.50 par value common stock outstanding at the end of its second year of operations. 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 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.

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. They are a distribution of the net income of a company and are not a cost of business operations. It’s crucial to understand that, from an accounting standpoint, a stock split is a purely cosmetic change.

First, a company often decides on a split when the stock price is relatively high, making it expensive for investors to acquire a standard board lot of 100 shares. A stock split is when a company divides its stock into multiple shares, effectively lowering the price of each share without changing the company’s market value. It’s akin to cutting a cake into smaller slices; you end up with more pieces, but the total amount stays the same. For instance, in a two-for-one split, an investor who owned one share priced at $100 would end up with two shares, each worth $50 but with the same total value.

This is the date that dividend payments are prepared andsent to shareholders who owned stock on the date of record. Therelated journal entry is a fulfillment of the obligationestablished on the declaration date; it reduces the Cash DividendsPayable account (with a debit) and the Cash account (with acredit). Recording small stock dividends A stock dividend of less than 20 to 25% of the outstanding shares is a small stock dividend and has little effect on the market value (quoted market price) of the shares.

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 how to file an extension for taxes 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.

Lastly, frequent stock splits might be seen as a form of financial engineering rather than a focus on fundamental business growth. There’s also a risk that the positive effects of a stock split may be short-lived. While splits often lead to a brief surge in stock price and trading volume, these effects tend to diminish over time. Any gains will likely be temporary if the underlying business fundamentals don’t support the optimism generated.