Magic Blades Stock Has Risen Rapidly To $50 Per Share

Magic Blades Stock Has Risen Rapidly To 50 Per Share The Increase I

Magic Blade's stock has experienced a significant increase to $50 per share, primarily driven by market excitement regarding their innovative knife that utilizes a light beam to slice fruits and vegetables. This technology purportedly improves the aesthetic and quality aspects of salads and fruit trays. In response to the stock's rise, the board of directors is considering strategies to divide the company's ownership into more shares of stock, specifically contemplating a stock split, small stock dividend, or large stock dividend, with the aim of reducing the share price.

The directors are uncertain about the accounting effects of these potential transactions and have requested information on how such activities would impact stockholders' equity. Their existing equity balance before the contemplated transactions is as follows: common stock with a $2 par value, 2,000,000 shares authorized, 500,000 shares issued and outstanding, amounting to $1,000,000; paid-in capital in excess of par totaling $2,000,000; and retained earnings of $6,000,000, resulting in total stockholders' equity of $9,000,000.

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Analyzing the impact of stock splits and stock dividends on stockholders' equity requires understanding the fundamental accounting principles behind these corporate actions. A stock split increases the number of shares outstanding while proportionally decreasing the par value per share, leaving total common stock and overall shareholders' equity unchanged. Conversely, a stock dividend issues additional shares to shareholders proportionally based on existing holdings, also redistributing retained earnings into paid-in capital, which results in changes to the composition of stockholders' equity but not its total amount.

(a) Impact of a 2-for-1 stock split: When a company declares a 2-for-1 stock split, the number of shares outstanding doubles, and the par value per share halves. Therefore, the common stock account, which is calculated as the number of shares issued times the par value, will double in shares but its dollar value will remain the same. Similarly, the total stockholders' equity experienced remains unaffected because no new assets or liabilities are introduced. The division simply redistributes existing equity across a greater number of shares, decreasing the per-share price but leaving total equity, including common stock, paid-in capital, and retained earnings, unchanged.

Specifically, prior to the split, common stock was valued at $2 per share with 500,000 shares issued, totaling $1,000,000. After the split, the number of shares issued would increase to 1,000,000, while the par value per share would decrease to $1. Consequently, the common stock account will remain at $1,000,000, assuming no change in share issuance or cancellation, and total stockholders' equity will stay at $9,000,000. The paid-in capital and retained earnings are unaffected directly by the split, so they remain unchanged.

(b) Impact of a 15% stock dividend: A stock dividend distributes additional shares to shareholders proportionally based on their existing holdings, effectively transferring an amount from retained earnings into paid-in capital. For a 15% stock dividend, shareholders receive 15 additional shares for every 100 held, increasing the number of shares issued. The value distribution depends on the market value per share, leading to a transfer of retained earnings equal to the market value of the shares issued, not their par value. Nonetheless, in accounting, this is recorded as a transfer of an amount equal to the stock's market value (or sometimes par value, depending on the accounting policy) from retained earnings to paid-in capital.

Assuming a market value of $50 per share, the number of shares issued as dividends would be 75,000 (15% of 500,000 shares). The total value distributed would be $3,750,000 (75,000 shares x $50 market value). This amount would be deducted from retained earnings and credited to paid-in capital in excess of par, reflecting a redistribution of accumulated earnings into contributed capital, but the total stockholders' equity remains unchanged at $9,000,000.

In summary, stock splits leave total stockholders' equity unchanged but alter the composition and per-share metrics, reducing the market price per share and increasing the number of shares outstanding. Stock dividends also do not alter total equity but transfer amounts from retained earnings to paid-in capital, reflecting a distribution of earnings in the form of additional shares.

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