Corporations sometimes order a stock split to lower the price per share of their common stock. While a split has no financial impact, some corporation boards believe that it is psychologically difficult for investors to buy shares of expensive stock, customarily referring to shares over $80 each. Stock splits have minimal impact on financial statements, and the impact is in the form of adjustments to previous information.
The dividing line between a stock split and stock dividend is arbitrary, but stock dividends of 50 percent or greater are customarily treated as stock splits. A stock split is specified as “X shares for Y.” For example, if you owned 100 shares each valued at $150 each, a 3-for-2 split would result in you owning 150 shares at $100 shares each. Your total stock value is unchanged at $15,000. You will not face any tax implications or other costs because of a split, though it’s possible you would have to pay a slightly higher commission to sell the greater number of shares. Splits do affect the par value of shares. Par value is an accounting term for some minimal value given to each issued share of stock, and has very little relevance for shareholders. In our example, a stock with a par value of $0.015 per share would be adjusted to $0.01 through an accounting memo.
Restatements for Splits
A stock split will cause certain financial ratios to be refigured, but no changes to the corporate financial reports. The only notice taken of the split will be an accounting footnote in the annual report. Some balance sheets state the number of outstanding shares and par values -- these figures will be updated by a split but have no financial impact. The earnings per share is the amount of net income for the quarter or the year divided by the stock price. A split changes the stock price without affecting earnings, so EPS declines. The practice is to historically restate pre-split EPS to avoid a discontinuity and the ensuing confusion. The dividend per share will also be adjusted downward. In this example, if the pre-split shares paid an annual dividend of $3.30 a share, the post-split dividend would be 2/3 of that value, or $2.20. The dividend yield, which is the dividend amount divided by the stock price, remains unchanged by a split. The same is true for the price-to-earnings ratio.
Stock Dividends –- Low Volume
Stock dividends are distributions of additional stock to shareholders, expressed as a percentage of existing shares. A low-volume stock dividend is one in which the number of new shares is less than 25 percent of outstanding shares, otherwise, it’s a high-volume dividend. If the dividend is 50 percent or higher, it's usually treated as a stock split. Both types of stock dividends reduce the balance in the retained earnings account. Low-volume splits reduce retained earnings by the market value of the new shares. This value is credited to two accounts: the amount that represents par value is assigned to the common stock account and the remainder is assigned to an account called additional paid-in capital.
Stock Dividends -– High Volume
High-volume stock dividends are valued at the par value of the new shares. This amount is subtracted from retained earnings and added to the common stock account.
Stock Dividends -– Financial Reporting
Stock dividends update the stockholders' equity section of the balance sheet. The retained earnings account reflects the cost of the dividend, and the common stock account shows an increase for part or all of the dividend cost. If the stock dividend is low volume, the additional paid-in capital account also shows part of the cost of the dividend. Stock dividends also affect the Statement of Retained Earnings. This statement highlights how earnings/losses for the period increase or decrease retained earnings and dividends decrease retained earnings. The ending balance on this report must match the balance sheet line for retained earnings. Stock dividends, like stock splits, require changes to earnings per share and dividends per share as noted earlier.
Video of the Day
- Stock Split Secret$: Profiting from a Powerful, Predictable, Price-Moving Event; Miles Nelson, Darlene Nelson
- Stock Investing For Dummies; Paul Mladjenovic
- Comstock/Comstock/Getty Images