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Chapter 15: Question 24Q (page 810)

Stock splits and stock dividends may be used by a corporation to change the number of shares of its stock outstanding.

  1. What is meant by a stock split effected in the form of a dividend?
  2. From an accounting viewpoint, explain how the stock split effected in the form of a dividend differs from an ordinary stock dividend.
  3. How should a stock dividend that has been declared but not yet issued be classified in a balance sheet? Why?

Short Answer

Expert verified

When the board of directors of a company decides to issue additional shares to the existing shareholders to increase the number of outstanding shares, it is called a stock split.

Step by step solution

01

Describing Stock Split Effect in the form of Dividend

A stock split in the form of a dividend is a distribution of corporate stock to current stockholders in proportion to each stockholder's current holdings, which is likely to result in a considerable drop in the stock's market price per share.

According to GAAP, the distribution of more than 20% to 25% of the number of shares previously outstanding would result in a considerable drop in the market price. This is a feature of a stock split rather than a stock dividend, but this distribution must be referred to as a "dividend for legal reasons."

As discussed above, it should be reported as a stock split in the form of a dividend from an accounting standpoint since it fulfills the accounting definition of a stock split.

02

Explaining the effect of Stock Split in the form of a Dividend Differs from an ordinary Stock dividend.

In terms of the amount of other paid-in capital or retained earnings to be capitalized, a stock split in the form of a dividend differs from an ordinary stock dividend. An ordinary stock dividend entails capitalizing (charging) retained earnings in the amount of the stock distributed fair value. When a stock split is done as a dividend, the par (stated) value of the additional shares issued is deducted from retained earnings.

A stock dividend differs from a stock split in that it usually entails the distribution of extra shares of the same class of stock with the same par or stated value

A stock split entails the distribution of extra shares of the same stock class with a commensurate drop in par or stated value. Before and after the stock split, the aggregate par or stated value would be the same.

03

Determining how a stock dividend that has been declared but not yet issued should be classified in a balance sheet.

A declared but unissued stock dividend should be classified as part of paid-in capital rather than debt in a balance sheet. Only capital accounts are affected by a stock dividend; retained earnings are reduced while paid-in capital is boosted.

As a result, there is no debt to pay and thus no severance of business assets when a stock dividend is given. Furthermore, stock dividends announced by a corporation's board of directors can be canceled by the board of directors at any moment prior to issuance.

Finally, the company will normally formally announce its intention to issue a certain number of extra shares, which must be set aside for this purpose.

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Most popular questions from this chapter

(Computation of Retained Earnings) The following information has been taken from the ledger accounts of Isaac Stern Corporation.

Total income since incorporation $317,000

Cash dividends paid 60,000

Total value of stock dividends distributed 30,000

Gains on treasury stock transactions 18,000

Unamortized discount on bonds payable 32,000

Instructions

Determine the current balance of retained earnings.

Nottebart Corporation has outstanding 10,000 shares of \(100 par value, 6% preferred stock and 60,000 shares of \)10 par value common stock. The preferred stock was issued in January 2017, and no dividends were declared in 2017 or 2018. In 2019, Nottebart declares a cash dividend of $300,000. How will the dividend be shared by common and preferred stockholders if the preferred is (a) noncumulative and (b) cumulative?

(Equity Items on the Balance Sheet) The following are selected transactions that may affect stockholders鈥� equity.

  1. Recorded accrued interest earned on a note receivable.
  2. Declared a cash dividend.
  3. Declared and distributed a stock split.
  4. Approved a retained earnings restriction.
  5. Recorded the expiration of insurance coverage that was previously recorded as prepaid insurance.
  6. Paid the cash dividend declared in item 2 above.
  7. Recorded accrued interest expense on a note payable.
  8. Declared a stock dividend.
  9. Distributed the stock dividend declared in item 8.

Instructions

In the following table, indicate the effect each of the nine transactions has on the financial statement elements listed. Use the following code: I = Increase, D = Decrease, NE = No effect.

Item

Asset

Liabilities

Stockholders鈥� Equity

Paid-in Capital

Retained

Earnings

Net Income

Woolford Inc. declared a cash dividend of $1.00 per share on its 2 million outstanding shares. The dividend was declared on August 1, payable on September 9 to all stockholders of record on August 15. Prepare all journal entries necessary on those three dates.

Washington Company has the following stockholders鈥� equity accounts at December 31, 2017.

Common Stock (\(100 par value, authorized 8,000 shares) \)480,000

Retained Earnings 294,000

Instructions

a. Prepare entries in journal form to record the following transactions, which took place during 2018.

1. 280 shares of outstanding stock were purchased at \(97 per share. (These are to be accounted for using the cost method.)

2. A \)20 per share cash dividend was declared.

3. The dividend declared in (2) above was paid.

4. The treasury shares purchased in (1) above were resold at \(102 per share.

5. 500 shares of outstanding stock were purchased at \)105 per share.

6. 350 of the shares purchased in (5) above were resold at \(96 per share.

b.Prepare the stockholders鈥� equity section of Washington Company鈥檚 balance sheet after giving effect to these transactions, assuming that the net income for 2018 was \)94,000. State law requires restriction of retained earnings for the amount of treasury stock.
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