Some Details on Stock Splits and Stock Dividends

Stock splits and stock dividends have essentially the same impacts on the corporation and the shareholder: they increase the number of shares outstanding and reduce the value per share. The accounting treatment is not the same, however, and it depends on two things: (1) whether the distribution is a stock split or a stock dividend and (2) the size of the stock dividend if it is called a dividend.

By convention, stock dividends of less than 20 to 25 percent are called small stock dividends. The accounting procedure for such a dividend is discussed next. A stock dividend greater than this value of 20 to 25 percent is called a large stock dividend. Large stock dividends are not uncommon. For example, in 2000, Corning announced a 200 percent stock dividend, and, in 1999, biotechnology company Amgen announced a 100 percent stock dividend, to name a few. Except for some relatively minor accounting differences, this has the same effect as a two-for-one stock split.

Example of a Small Stock Dividend The Peterson Co., a consulting firm specializing in difficult accounting problems, has 10,000 shares of stock outstanding, each selling at $66. The total market value of the equity is $66 X 10,000 = $660,000. With a 10 percent stock dividend, each stockholder receives one additional share for each 10 owned, and the total number of shares outstanding after the dividend is 11,000.

Before the stock dividend, the equity portion of Peterson's balance sheet might look like this:

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

18. Dividends and Dividend Policy

© The McGraw-Hill Companies, 2002

CHAPTER 18 Dividends and Dividend Policy

Common stock ($1 par, 10,000 shares outstanding) Capital in excess of par value Retained earnings Total owners' equity

A seemingly arbitrary accounting procedure is used to adjust the balance sheet after a small stock dividend. Because 1,000 new shares are issued, the common stock account is increased by $1,000 (1,000 shares at $1 par value each), for a total of $11,000. The market price of $66 is $65 greater than the par value, so the "excess" of $65 X 1,000 shares = $65,000 is added to the capital surplus account (capital in excess of par value), producing a total of $265,000.

Total owners' equity is unaffected by the stock dividend because no cash has come in or out, so retained earnings is reduced by the entire $66,000, leaving $224,000. The net effect of these machinations is that Peterson's equity accounts now look like this:

Common stock ($1 par, 11,000 shares outstanding)

$ 11,000

Capital in excess of par value

265,000

Retained earnings

224,000

Total owners' equity

$500,000

Example of a Stock Split A stock split is conceptually similar to a stock dividend, but it is commonly expressed as a ratio. For example, in a three-for-two split, each shareholder receives one additional share of stock for each two held originally, so a three-for-two split amounts to a 50 percent stock dividend. Again, no cash is paid out, and the percentage of the entire firm that each shareholder owns is unaffected.

The accounting treatment of a stock split is a little different from (and simpler than) that of a stock dividend. Suppose Peterson decides to declare a two-for-one stock split. The number of shares outstanding will double to 20,000, and the par value will be halved to $.50 per share. The owners' equity after the split is represented as:

Common stock ($.50 par, 20,000 shares outstanding)

$ 10,000

Capital in excess of par value

200,000

Retained earnings

290,000

Total owners' equity

$500,000

Note that, for all three of the categories, the figures on the right are completely unaffected by the split. The only changes are in the par value per share and the number of shares outstanding. Because the number of shares has doubled, the par value of each is cut in half.

Example of a Large Stock Dividend In our example, if a 100 percent stock dividend were declared, 10,000 new shares would be distributed, so 20,000 shares would be outstanding. At a $1 par value per share, the common stock account would rise by $10,000, for a total of $20,000. The retained earnings account would be reduced by $10,000, leaving $280,000. The result would be the following:

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

18. Dividends and Dividend Policy

© The McGraw-Hill Companies, 2002

PART SIX Cost of Capital and Long-Term Financial Policy

Common stock ($1 par, 20,000 shares outstanding) Capital in excess of par value Retained earnings Total owners' equity

Insiders Online Stocks Trading Tips

Insiders Online Stocks Trading Tips

We Are Not To Be Held Responsible If Your Online Trading Profits Start To Skyrocket. Always Been Interested In Online Trading? But Super-Confused And Not Sure Where To Even Start? Fret Not! Learning It Is A Cakewalk, Only If You Have The Right Guidance.

Get My Free Ebook


Post a comment