14 3: Stock Dividends and Splits Business LibreTexts

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.

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When declaring stock dividends, companies issue additional shares of the same class of stock as that held by the stockholders. Stock splits are events that increase the number of shares outstanding and reduce the par or stated value per share. For example, a 2-for-1 stock split would double the number of shares outstanding and halve the par value per share. A stock split occurs when a company increases the number of outstanding shares with a proportional decrease in the par or stated value.

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• Only the par value and the number of issued and outstanding shares are different.
• When declaring stock dividends, companies issue additional shares of the same class of stock as that held by the stockholders.
• In particular, the corporation must obtain a change in the par value (if any) and an increase in the number of authorized shares.
• 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.
• In May 2011, Citigroup reverse split its shares 1-for-10 in an effort to reduce its share volatility and discourage speculator trading.

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 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.

Does a stock split make a better investment?

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.

For example, a stockholder who owns 1,000 shares in a income summary 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. Stock dividends and stock splits affect the number of common shares outstanding, which in turn influences the earnings per share (EPS) calculation. 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.

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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 Bookstime will own 125 shares after a 25% stock dividend (essentially the same result as a 5 for 4 stock split).

• 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.
• For stock dividends, most states permit corporations to debit Retained Earnings or any paid-in capital accounts other than those representing legal capital.
• When a stock splits, it can also result in a share price increase following a decrease immediately after the split.
• Although shareholders will perceive very little difference between a stock dividend and stock split, the accounting for stock dividends is unique.
• 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.

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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 circumstances, however, they debit Retained Earnings when a stock dividend is declared. If the event is a stock split, there is no change in either Retained Earnings or Common Stock, only a decrease in par value and an increase in the number of issued and outstanding shares. Large increases in the number of shares are achieved through stock splits and large stock dividends. A stock split happens when a corporation increases the number of its common shares and proportionally decreases its par or stated value.

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