Stock Dividends and Splits | Financial Accounting (2024)

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.

Stock dividends are payable in additional shares of the declaring corporation’s capital stock. When declaring stock dividends, companies issue additional shares of the same class of stock as that held by the stockholders.

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. For stock dividends, most states permit corporations to debit Retained Earnings or any paid-in capital accounts other than those representing legal capital. In most circ*mstances, however, they debit Retained Earnings when a stock dividend is declared.

Stock dividends have no effect on the total amount of stockholders’ equity or on net assets. They merely decrease retained earnings and increase paid-in capital by an equal amount. Immediately after the distribution of a stock dividend, each share of similar stock has a lower book value per share. This decrease occurs because more shares are outstanding with no increase in total stockholders’ equity.

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.

A corporation might declare a stock dividend for several reasons:

  • Retained earnings may have become large relative to total stockholders’ equity, so the corporation may desire a larger permanent capitalization.
  • The market price of the stock may have risen above a desirable trading range. A stock dividend generally reduces the per share market value of the company’s stock.
  • The board of directors of a corporation may wish to have more stockholders (who might then buy its products) and eventually increase their number by increasing the number of shares outstanding. Some of the stockholders receiving the stock dividend are likely to sell the shares to other persons.
  • Stock dividends may silence stockholders’ demands for cash dividends from a corporation that does not have sufficient cash to pay cash dividends.

The percentage of shares issued determines whether a stock dividend is a small stock dividend or a large stock dividend. Firms use different accounting treatments for each category.

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. Thus, the firm accounts for the dividend at the current market value of the outstanding shares.

Assume a corporation is authorized to issue 20,000 shares of $100 par value common stock, of which 8,000 shares are outstanding. Its board of directors declares a 10% stock dividend (800 shares). The quoted market price of the stock is $125 per share immediately before the stock dividend is announced. Since the distribution is less than 20 to 25 per cent of the outstanding shares, the dividend is accounted for at market value. The entry for the declaration of the stock dividend onAugust 10, is:

DebitCredit
Aug. 10Retained earnings (or Stock Dividends) (800 shares x $125)100,000
Common stock dividend distributable(800 shares x $100 par value)80,000
Paid-In capital – Common Stock ($100,000 market value – $80,000 par)20,000
To record the declaration of a 10% stock dividend

This entry records the issuance of the shares:

DebitCredit
Sept. 20Common stock dividend distributable80,000
Common stock80,000

The common stock dividend distributable account is a stockholders’ equity (paid-in capital) account credited for the par or stated value of the shares distributable when recording the declaration of a stock dividend until the stock is issued to shareholders. Since a stock dividend distributable is not to be paid with assets, it is not a liability.

Suppose, on the other hand, that the common stock in the preceding example is no-par stock and has a stated value of $50 per share. The entry to record the declaration of the stock dividend (when the market value is $125) is:

DebitCredit
Retained earnings (800 shares x $125 market value)100,000
Common stock dividends distributable (800 shares x $50 stated value)40,000
Paid-in capital in excess of stated, Common ($100,000 market – $40,000 stated value)60,000

Stock Splits

A company can control their market price in some cases. When the market price is too high, people will not invest in the company. What can we do? We can split our stock! A stock splits does not cause an accounting entry as it does not change any monetary amounts listed on the financial statements. What does it do?

  • Shares increase by number of the stock split
  • Par value decreases by the number of the stock split

As an example, think ofa pizza. The pizza has 8 slices and costs $16 per pizza which is $2 per share ($16 price / 8 slices). I ask the pizza parlor to double-cut the pizza into 16 slices instead of 8 slices. The cost of my pizza is still $16 but the cost per slice is now $1 per slice ($16 cost / 16 slices).

The 8 slices of a typical pizza represent the shares of 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.

Accounting in the Headlines

In June 2014, Apple, Inc. (AAPL) did a 7-for-1 stock split, meaning that an investor who previously held one share of Apple stock would have seven shares on the date of the split. Before the split, Apple had 861 million shares of stock valued at roughly $650 each. After the split, Apple had approximately 6 billion shares valued at roughly $94 per share. (The total market value of Apple’s stock increased on the date of the stock split due to market fluctuation; the stock split had no immediate impact on the value of Apple.)

Apple stated that it executed this 7-for-1 stock split because it wanted to make its shares available to more investors. Due to the split, the market price per share would go from about $650 per share down to about $94 per share, making the stock affordable for more people.

The par value of Apple’s common stock is $0.00001 per share as of September 27, 2014 (Apple’s year end.)

Apple has split its stock four times since it began operations. Three times, Apple has conducted a two-for-one stock split (in 1987, 2000, and 2005.) If you had purchased one share of Apple stock at its original issuance on December 12, 1980 ($22 per share market price), you would have 56 shares today.

Questions

  1. What impact does the stock split have on Apple’s total stockholders’ equity?
  2. What impact does a stock split have on a stock’s par value? Explain.
  3. Has the par value of one share of Apple stock changed since it was originally issued in 1980? Explain.

As an expert in financial accounting and corporate finance, I'll provide a detailed analysis of the concepts mentioned in the article and address the questions raised at the end.

Stock Dividends: The article discusses the issuance of stock dividends by companies that lack sufficient cash for a cash dividend. It emphasizes that in the long run, reinvesting capital in the business may be more beneficial than paying cash dividends. Stock dividends are explained as additional shares of the same class of stock issued to shareholders. The accounting treatment involves transferring sums from retained earnings to permanent paid-in capital. Stock dividends do not affect the total amount of stockholders' equity or net assets, but they decrease retained earnings and increase paid-in capital.

Reasons for Declaring Stock Dividends: Several reasons for declaring stock dividends are presented, including a desire for larger permanent capitalization, controlling market stock prices, and satisfying stockholders' demands for dividends.

Types of Stock Dividends: The article distinguishes between small and large stock dividends based on the percentage of outstanding shares issued. Small stock dividends, less than 20 to 25% of outstanding shares, are accounted for at the current market value, while large stock dividends involve different accounting treatments.

Accounting Entries for Stock Dividends: The article provides specific examples of accounting entries for a 10% stock dividend, detailing entries for the declaration and issuance of the dividend. The entries vary depending on factors such as par value and market value of the stock.

Stock Splits: The article introduces stock splits as a way for companies to control their market prices. It clarifies that stock splits do not cause accounting entries but result in an increase in the number of shares and a decrease in par value. A practical example involving a pizza analogy is given to illustrate the concept.

Apple's Stock Split Example: The article cites Apple's 7-for-1 stock split in 2014 and explains the rationale behind it—to make shares more affordable to a broader range of investors. The impact on Apple's total stockholders' equity and the par value of its stock is discussed.

Answering the Questions:

  1. Impact on Apple's total stockholders' equity: A stock split has no impact on total stockholders' equity. While the number of shares increases, the par value decreases proportionally, leaving the total equity unchanged.

  2. Impact on a stock's par value: A stock split reduces the par value per share. In the case of Apple, the par value per share decreased from the original $0.00001 to a lower value after the stock splits.

  3. Change in the par value of one share of Apple stock since 1980: The par value of one share of Apple stock has decreased due to the stock splits. Initially, it was $0.00001, and after the splits, it is now even lower. However, it's essential to note that the market price of the stock is influenced by various factors, and the par value is a nominal amount.

In conclusion, the concepts covered in the article include stock dividends, reasons for declaring them, accounting entries for different types, stock splits, and a practical example with Apple's stock split. If you have any further questions or need additional clarification, feel free to ask.

Stock Dividends and Splits | Financial Accounting (2024)

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