When a split occurs, the market value per share is reduced to balance the increase in the number of outstanding shares. In a 2-for-1 split, for example, the value per share typically will be reduced by points, lines and curves 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.
- For example, if a firm’s stock is currently selling for $240 and the firm splits its stock 4 for 1, the price per share will fall to around $60.
- While this effect may wane over time, stock splits by blue-chip companies are a bullish signal for investors.
- For example, if a stock split happens, the prior year’s earnings per share figure should be altered to account for the larger number of shares.
A 3-for-1 stock split means that for every one share held by an investor, there will now be three. In other words, the number of outstanding shares in the market will triple. The key advantage of a stock split is an increase in the number of shares outstanding and therefore an increase in free float. Along with the fact that the stock price is decreasing in proportion to the split ratio, this makes them more affordable to investors and increases their liquidity. As a result, the corporation reduces the par value of its stock from $15 to $5 and increases the number of shares issued and outstanding from 50,000 to 150,000.
Other Stock Splits
In
addition, corporations use dividends as a marketing tool to remind
investors that their stock is a profit generator. Stock splits are usually done by companies whose stock prices get really high and it is desired to lower their value. This allows them to get more investors because they can appeal to a broader base of investors. At one point, Apple stock price was over $700 a share, so they did a 7-for-1 stock split in 2014. What that meant is that for every one share a shareholder had before at $700, they now had 7 shares at $100 each.
- Prior to the distribution, the
company had 60,000 shares outstanding. - A stock split is a major managerial decision that profoundly impacts the par and market values of individual shares of a company.
- There are two methods that are commonly used in accounting for Stock Splits.
- Therefore, a split is often the result of growth or the prospects of future growth, and it’s a positive signal.
- A memorandum notation in the accounting records indicates the decreased par value and an increase in the number of shares.
Splitting the stock brings the share price down to a more attractive level. The actual value of the company doesn’t change but the lower stock price may affect the way the stock is perceived and this can entice new investors. Yet another use for a stock split is when there are a few shareholders whose holdings are inconsequential, usually less than 100 shares each.
What Is a Stock Split?
The board of directors of a firm can split the stock in any ratio they want. A stock split could be 2-for-1, 3-for-1, 5-for-1, 10-for-1, 100-for-1, and so on. A three-for-one stock split indicates that for every share an investor currently has, they will now own three. To put it another way, the total number of outstanding shares on the market will triple.
If a company’s stock has no par value, then no reallocation of funds into the par value account is required. You have just obtained your MBA and obtained your dream job with
a large corporation as a manager trainee in the corporate
accounting department. 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.
Comparing Small Stock Dividends, Large Stock Dividends, and Stock Splits
A large stock dividend (generally over the 20-25% range) is accounted for at par value. A small stock dividend occurs when a stock
dividend distribution is less than 25% of the total outstanding
shares based on the shares outstanding prior to the dividend
distribution. 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.
ESOPs for Small and Medium Enterprises (SMEs): Tailoring Equity Plans for Success
Treasury shares are not outstanding, so no dividends are declared or distributed for these shares. Regardless of the type of dividend, the declaration always causes a decrease in the retained earnings account. A reverse/forward stock split is a special stock split strategy used by companies to eliminate shareholders holding less than a certain number of shares. A reverse/forward stock split consists of a reverse stock split followed by a forward stock split. The reverse split reduces the overall number of shares a shareholder owns, causing some shareholders who hold less than the minimum required by the split to be cashed out. The forward stock split then increases the number of shares owned by the remaining shareholders.
They’re held by the public, either through individual ownership or as components of a pension fund or mutual fund. None of these reasons or potential effects agree with financial theory, however. Splits are a good demonstration of how corporate actions and investor behavior don’t always fall in line with financial theory.
No change occurs to the dollar amount of any general ledger account. 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).
Most investors are more comfortable purchasing, say, 100 shares of a $10 stock as opposed to 1 share of a $1,000 stock. So when the share price has risen substantially, many public companies end up declaring a stock split to reduce it. Although the number of shares outstanding increases in a stock split, the total dollar value of the shares remains the same compared with pre-split amounts, because the split does not make the company more valuable. A stock split is a corporate action in which a company issues additional shares to shareholders, increasing the total by the specified ratio based on the shares they held previously. Companies often choose to split their stock to lower its trading price to a more comfortable range for most investors and to increase the liquidity of trading in its shares. For recording purpose, a reverse stock split does not require a double entry accounting because it does not affect the ultimate reporting amount of any item in stockholders’ equity.