Stock Split And Stock Dividend Of Common Stock

stock Split And Stock Dividendthe Common Stock O

Question 1 (Stock Split and Stock Dividend) The common stock of Warner Inc. is currently selling at $110 per share. The directors wish to reduce the share price and increase share volume prior to a new issue. The per share par value is $10; book value is $70 per share. Five million shares are issued and outstanding.

a. How much is the debit to retained earnings if the board votes a 2-for-1 stock split?

b. Prepare the necessary journal entries if the board votes a 100% stock dividend.

Paper For Above instruction

Introduction

Stock splits and stock dividends are fundamental corporate actions that impact a company's share structure and investor perception. Warner Inc., facing the need to lower its share price to attract more investors, plans to implement both a stock split and a stock dividend. Understanding these actions' accounting and economic implications is essential for accurate financial reporting and strategic decision-making.

Stock Split Analysis

A stock split involves increasing the number of shares outstanding by issuing more shares to existing shareholders, effectively reducing the stock price proportionally without altering the company's total market value. Warner Inc. proposes a 2-for-1 stock split, doubling the number of shares and halving the stock price, making the shares more accessible to small investors. The key accounting aspect is determining the reduction in retained earnings and the impact on the company's capital structure.

Debit to Retained Earnings Calculation

Given that the current share price is $110, and the par value is $10, the stock's total market capitalization for 5 million shares is:

  • Total Market Capitalization = 5,000,000 shares × $110 = $550 million

Post-split, the company will have 10 million shares, each at a new price of approximately $55 (assuming the market sees the split as purely structural). The accounting treatment for a stock split involves no change in total equity; however, for formal accounting, the par value per share increases in the books to reflect the split, and the reduction from retained earnings corresponds to the total par value of the new shares issued.

Since the total shares double, the debit to retained earnings (or paid-in capital in some cases) is calculated based on the total par value of the new shares issued:

  • Additional shares issued = 5 million (original shares) × (2-1) = 5 million shares
  • Par value per share after split = $10
  • Total par value of new shares = 5 million × $10 = $50 million

However, since the company's book value per share is $70, and the stock is being split without affecting the book value, the total decrease in retained earnings recognized on the books is $50 million, corresponding to the increase in stated capital.

Therefore, the debit to retained earnings is approximately $50 million.

Journal Entry for Stock Split:

No journal entry is required for a stock split as it is a memorandum entry. However, the detailed accounting involves adjusting the common stock account and possibly other equity accounts to reflect the new par value and the increased number of shares without affecting total equity.

Stock Dividend Analysis

A 100% stock dividend entails distributing additional shares to shareholders equivalent to their current holdings, effectively doubling the number of shares outstanding. Unlike a stock split, a stock dividend often requires a journal entry to transfer a portion of retained earnings to common stock and additional paid-in capital, depending on the dividend size and company policy.

Journal Entry for 100% Stock Dividend

  • Shares outstanding before dividend: 5 million
  • Shares distributed: 5 million (a 100% dividend)
  • Total shares after dividend: 10 million
  • Market value per share before dividend: $110
  • Total value of dividend shares: 5 million × $110 = $550 million

Accounting treatment involves transferring the fair value of the stock dividend from retained earnings to common stock and additional paid-in capital in proportions based on the issuance price and the company's policies. Assuming the dividend is distributed at prevailing market value, the journal entry would be:

Retained Earnings           $550,000,000

Common Stock (par value)             $50,000,000


Additional Paid-in Capital          $500,000,000

This entry reflects increasing common stock at par value and capturing the excess as additional paid-in capital.

Conclusion

Both stock splits and stock dividends serve strategic purposes but differ in accounting treatment and shareholder impact. The stock split primarily reorganizes existing capital without affecting retained earnings, while the stock dividend involves transferring retained earnings to capital accounts. Proper understanding and accurate recording of these transactions are essential for transparent financial reporting and maintaining investor confidence.

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