14 3: Stock Dividends and Splits Business LibreTexts

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• Since the number of outstanding shares has changed but the par value per share (or its equivalent) remains the same, there must be a credit to the capital stock account equal to the par value of the newly issued shares.
• A high stock price can deter potential investors, particularly smaller ones, therefore a lower price can make it more appealing and accessible.
• To continue with the example, let’s say the shares were trading at $20 at the time of the 2-for-1 split; after the split, the number of shares doubles and the shares trade at $10 instead of $20.
• For example, in a reverse 1-for-5 split, 10 million outstanding shares at 50 cents each would now become 2 million shares outstanding at $2.50 per share.
• As a result, stock splits help make shares more affordable to small investors and provides greater marketability and liquidity in the market.

Which of these is most important for your financial advisor to have?

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Financial Accounting

For example, if an investor shorts 100 shares of XYZ Corp. at $25, he or she will be required to return 100 shares of XYZ to the lender at some point in the future. If the stock undergoes a 2-for-1 split before the shares are returned, it simply means that the number of shares in the market will double along with the number of shares that need to be returned. For example, in a reverse 1-for-5 split, 10 million outstanding shares at 50 cents each would now become 2 million shares outstanding at $2.50 per share. The percentage of shares issued determines whether a stock dividend is a small stock dividend or a large stock dividend.

Why do companies split their stocks?

A) Lower the trading price of the stock per share.B) Increase the number of authorized shares.C) Increase legal capital.D) Increase the number of outstanding shares. The 8 slices of a typical pizza represent the shares of cash flow stock and the $2 cost per share is the par value of the stock. When I double cut the pizza, this represents a 2-1 stock split with 16 shares of stock (or slices of pizza) for the new par value of $1 per share. The current year’s EPS is calculated based on the number of common shares after any stock dividends and splits. Rapidly growing companies often have share splits to keep the per share price from reaching stratospheric levels that could deter some investors. In the final analysis, understand that a stock split is mostly cosmetic as it does not change the underlying economics of the firm.

• Achieving an increase in the number of shares by a formal stock split necessitates a potentially difficult legal process, primarily because the action requires an amendment of the corporate charter granted by the authorities.
• The biggest change that happens to the portfolio is the number of shares being shorted and the price per share.
• A stock split is a decision by a company’s board of directors to increase the number of shares that are outstanding by issuing more shares to current shareholders.
• They merely decrease retained earnings and increase paid-in capital by an equal amount.
• Stock dividends are payable in additional shares of the declaring corporation’s capital stock.
• For example, a 2-for-1 stock split would double the number of shares outstanding and halve the par value per share.

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.

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• Only the par value and the number of issued and outstanding shares are different.
• However, if this event is a stock dividend, the stock’s par or stated value will not change, but Retained Earnings will decrease and Common Stock will increase.
• In May 2011, Citigroup reverse split its shares 1-for-10 in an effort to reduce its share volatility and discourage speculator trading.
• Stock dividends are recorded by moving amounts from retained earnings to paid-in capital.
• When declaring stock dividends, companies issue additional shares of the same class of stock as that held by the stockholders.
• Instead of going through the legal steps required for a split, the board of directors can simply declare a large stock dividend and distribute the shares to the stockholders.

The main reason for issuing large stock dividends and stock splits is to lower the trading price of the stock per share. By increasing the number of shares each investor holds, the individual price of each share is reduced. A high stock price can deter potential investors, particularly smaller ones, therefore a lower price can make it more appealing and accessible. Meanwhile, the splits or large dividends do not increase the company’s authorized shares nor their legal capital, as it merely divides the existing shares into multiple parts. In contrast to cash dividends discussed earlier in this chapter, stock dividends involve the issuance of additional shares of stock to existing shareholders on a proportional basis. For example, a shareholder who owns 100 shares of stock will own 125 shares after a 25% stock dividend (essentially the same result as a 5 for 4 stock split).

• When a significant increase in shares is accomplished by declaring a large stock dividend, this may be described as a split instead of a dividend.
• For stock dividends, most states permit corporations to debit Retained Earnings or any paid-in capital accounts other than those representing legal capital.
• Although shareholders will perceive very little difference between a stock dividend and stock split, the accounting for stock dividends is unique.
• 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.
• All publicly traded companies have a set number of shares that are outstanding.
• The end result is a doubling, tripling, or quadrupling of the number of outstanding shares and a corresponding decrease in the market price per share of the stock.