Stock split is also known as a scrip issue, bonus issue, capitalization issue or free issue.
When a company divides the existing shares (stocks) into multiple new shares, it is known as stock split.
It is done to boost the stock’s liquidity.
Here, stock liquidity means conversion of shares into ready cash without affecting its market price.
Stock split increases number of outstanding shares by a specific multiple but the total capital value of the shares remains the same.
Some split ratios are 2-for-1 or 3-for-1, 5-for-1, 10-for-1, 100-for-1 etc.
The most common split ratios are 2-for-1 or 3-for-1; sometimes it is denoted as 2:1 or 3:1.
2-for-1 means the stockholder will have two shares will receive one share at present.
3-for-1 means the stockholder will have three shares will receive one share at present.
Stock splits are events that increase the number of shares outstanding and reduce the par or face value per share.
Existing shareholders would see their shareholdings double in quantity, but there would be no changes in the proportional ownership.
For example, a shareholder having 1,000 shares out of 100,000 would then own 2,000 shares out of 200,000.
Reverse stock splits are effectively the opposite transaction, where a company divides, instead of multiplies, the number of shares that stockholders own, raising the market price accordingly.
Accounting treatment
When a company splits its shares, it recalls all the shares outstanding.
Then the company issues more new shares to replace them.
Many companies try this idea to keep their stock price unchanged.
Splitting shares need a significant expense.
Shareholders might question why the company is spending money that way.
Splitting of the stock increases liquidity.
The company can use bid-ask spread on a percentage basis to reduce expenses.
A stock’s price is also affected by a stock split.
After a split, the stock price will be reduced since the number of shares outstanding has increased.
In the example of a 2-for-1 split, the share price will be halved.
Thus, the number of outstanding shares and the stock price change, the market capitalization remains constant.
A stock split is usually done by companies when their share price increase either a certain levels or too high
The primary motive is to make shares seem more affordable to small investors even though the underlying value of the company has not changed.
The price of a split stock can also increase immediately after the split.
Since many small investors think the stocks is now more affordable and they buy the stock.
These investors boost demand and increase the prices of the stock.
Another reason for the price increase is that a stock split provides a signal to the market.
The company’s share price has been increasing and people assume this growth will continue in the future, and again, boost demand and prices.
Another version of a stock split is the reverse split.
This procedure is typically used by companies with low share prices.
Many stock exchanges will delist stocks if they fall below a certain price per share.
Stock split increases prices in the market and it helps to prevent the company from being delisted.
Thus, a stock split help to small investors and provides greater marketability and liquidity in the market.
Stock Dividends |
Stock Splits |
In stock dividend, the par value of a stock does not change. |
In stock splits, the par value of a stock decreases. |
Total number of stocks (shares) increases. |
Total number of stocks (shares) increases. |
Total stockholders’ equity does not change; here, retained earnings decrease but stocks increase. |
Total stockholders’ equity does not change; retained earnings and stocks are same. |
Stock dividends require journal entries. |
Stock splits do not require journal entries. |
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Journal Entries |
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Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7A
ABC Company Ltd has following extracted information:
100,000 common stocks of $10 at par
On 1st July, the company declares and issues a 2-for-1 stock split.
Calculate the number of shares issued and value par value of a share
[Answer: 20,000 shares; $5]
SOLUTION:
After 2-for-1 stock split:
No. of share issued = 100,000 x 2/1 = 200,000 shares
Value of one share = $10 x 1/2 = $5
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7B
AB Company Ltd has following extracted information:
Common stock of $15 at par: 90,000 stocks issued and outstanding
On 1st October, the company declares and issues a 3-for-1 stock split.
Calculate the number of shares issued and value par value of a share
[Answer: 270,000 stocks; $5]
SOLUTION:
After 3-for-1 stock split:
No. of share issued = 90,000 x 3/1 = 270,000 stocks
Value of one share = $15 x 1/3 = $5
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7C
ABC Company Ltd has following shareholders’ equity:
Particulars |
Amount $ |
|
Common stock |
(1,000 shares issued and outstanding @ $100) |
100,000 |
8% Preferred stock |
(1,000 shares issued and outstanding @ $100) |
100,000 |
Additional paid in capital |
(share premium) |
20,000 |
Retained earnings |
|
80,000 |
Total stockholders’ equity |
300,000 |
Given and working note:
There is the 2-for-1 common stock split.
New price of common stocks = $100 x ½ = $50
No. of new common stocks = 1,000 x 2 = 2,000
The stockholders’ equity section is adjusted in the following ways:
Particulars |
Amount $ |
|
Common stock |
(2,000 shares issued and outstanding @ $50) |
100,000 |
8% Preferred stock |
(1,000 shares issued and outstanding @ $100) |
100,000 |
Additional paid in capital |
(share premium) |
20,000 |
Retained earnings |
|
80,000 |
Total stockholders’ equity |
300,000 |
Keep in Mind
In the PROBLEM: 7C, there are 1000 shares @ $100 = $100,000 |
Company split 2-for-1 common stock becomes from $100 to $50 |
Here, number of shares becomes from 1,000 to 2,000 |
But value of capital remains same $100,000 |
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PROBLEMS AND ANSWERS OF STOCK SPLIT, 2-for-1, 3-for-1 |
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7A
ABC Company Ltd has following extracted information:
Common stock of $20 at par: 50,000 stocks issued and outstanding
On 1st October, the company declares and issues a 2-for-1 stock split.
Calculate the number of shares issued and value par value of a share
[Answer: 100,000 stocks; $10]
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7B
ABC Company Ltd has following extracted information:
Common stock of $30 at par: 50,000 stocks issued and outstanding
On 1st October, the company declares and issues a 3-for-1 stock split.
Calculate the number of shares issued and value par value of a share
[Answer: 150,000 stocks; $10]
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = ₦ = Birr = Currency of your country
PROBLEM: 7C
The stockholders equity of EP Company Ltd appeared as follows:
Liabilities |
Amount |
Common stock of $10 at par: 50,000 shares issued and outstanding |
5,00,000 |
Additional paid in capital |
7,50,000 |
Retained earnings |
8,80,000 |
Total stockholders’ equity |
21,30,000 |
The company has chosen stock split and declare on 1st July as 2-for-1 split.
Required: Stockholders equity of the company after stock split
[Answer: 100,000 stocks; $5]
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