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Chapter 11: Problem 15

Large Stock Dividend and Forward Stock Split Kitch Corporation has 50,000 shares of \$5 par value common stock outstanding and retained earnings of \(\$ 820,000\). The company declares a 100 percent stock dividend. The market price at the declaration date is \(\$ 17\) per share. a. Prepare the journal entries for (1) the declaration of the dividend and (2) the issuance of the dividend. b. Assume that the company splits its stock 5 -for-1 and reduces the par value from \(\$ 5\) to \(\$ 1\) rather than declaring a 100 percent stock dividend. How does the accounting for the forward stock split differ from the accounting for the 100 percent stock dividend?

Short Answer

Expert verified
A stock dividend reallocates equity, changing retained earnings and capital, whereas a stock split simply changes the number of shares and par value without affecting total equity.

Step by step solution

01

Understand the Situation

Kitch Corporation has 50,000 shares with each having a $5 par value. When a 100% stock dividend is declared, you double the number of shares: 50,000 additional shares will be issued. The market price per share is $17, but the par value remains at $5.
02

Record the Declaration of Dividend

For the declaration of the stock dividend, reduce Retained Earnings by the par value of the new shares issued (50,000 shares * \(5 par value). Record this in the journal as: \[ \text{Debit: Retained Earnings } (50,000 \times 5) = \\)250,000 \] \[ \text{Credit: Common Stock Dividend Distributable } \$250,000 \]
03

Record the Issuance of Dividend

Upon issuing the dividend, transfer the amount from the Common Stock Dividend Distributable to Common Stock: \[ \text{Debit: Common Stock Dividend Distributable } \\(250,000 \] \[ \text{Credit: Common Stock } \\)250,000 \]
04

Understanding Stock Split

For a 5-for-1 forward stock split, the number of shares increases fivefold, changing from 50,000 shares to 250,000 shares. The par value is reduced from $5 to $1, but there no change is made to retained earnings or total paid-in capital.
05

Compare Stock Split and Dividend

The key difference is that a stock dividend affects the retained earnings and moves funds into paid-in capital, whereas a stock split only changes the number of shares and par value without affecting the financial statements' equity sections.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Journal Entries
In financial accounting, journal entries are fundamental for recording transactions. Each transaction is documented in a journal with corresponding debit and credit entries.
This ensures that the accounting equation, Assets = Liabilities + Equity, remains balanced. For Kitch Corporation鈥檚 100% stock dividend:
  • Declaration of Dividend: When the dividend is declared, the entry reduces Retained Earnings by $250,000 and creates a Common Stock Dividend Distributable liability of $250,000. This marks an obligation to distribute shares to existing shareholders.
  • Issuance of Dividend: When shares are issued as dividends, debit Common Stock Dividend Distributable and credit Common Stock, thereby fulfilling the company鈥檚 obligation.
These journal entries ensure accurate reflection of stock dividend impacts in financial records.
Stock Dividend
A stock dividend involves the distribution of additional shares to existing shareholders, instead of cash. For Kitch Corporation, this meant issuing an extra 50,000 shares, which doubled the current shares.
Even though market value is considered, the transaction is recorded at par value, which for each share is $5.
  • Effect on Financial Statements: Stock dividends reduce Retained Earnings but increase the paid-in capital (Common Stock).
  • Impact on Shareholders: Shareholders receive additional shares, which might not immediately affect their total stock value, since the market adjusts the share price to account for the increased supply.
Stock dividends are a way to reward shareholders without impacting cash flow.
Forward Stock Split
In a forward stock split, the number of shares increases, and the par value per share decreases, without changing the overall value of the equity.
For Kitch Corporation鈥檚 5-for-1 split, the shares increased from 50,000 to 250,000, while the par value dropped from $5 to $1.
  • No Impact on Overall Value: Though the share count multiplies, the markets adjust the share price accordingly, keeping the total market capitalization unchanged.
  • Comparison to Stock Dividend: Unlike stock dividends, forward stock splits do not affect Retained Earnings or the financial equity accounts.
Forward stock splits are often used to make shares more affordable and attractive to investors by lowering the per-share price.
Retained Earnings
Retained Earnings represent the cumulative net income a company retains, rather than distributing as dividends. For Kitch Corporation, prior to the stock dividend, Retained Earnings stood at $820,000.
In a stock dividend, this account decreases, as evidenced by the $250,000 reduction during the dividend declaration.
  • Role in Stock Dividend: Retained Earnings are transferred to paid-in capital accounts during stock dividends, reducing the balance while expanding the capital structure.
  • Importance: They reflect the company鈥檚 ability to reinvest in growth or maintain stability by not distributing all profits.
Understanding retained earnings is crucial for grasping how profits are allocated within a company and assessing long-term financial health.

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Most popular questions from this chapter

Which type of stock may have dividends in arrears? a. Cumulative preferred stock b. Common stock c. Noncumulative preferred stock d. Treasury stock

Stockholders' Equity Transactions, Journal Entries, and T-Accounts The stockholders' equity of Black Corporation at January 1 follows: The following transactions, among others, occurred during the year: Jan. 1 Announced a 4-for- 1 common stock split, reducing the par value of the common stock to \(\$ 0.25\) per share. Mar. 31 Converted \(\$ 75,000\) face value of convertible bonds payable (the book value of the bonds was \(\$ 83,000\) ) to common stock. Each \(\$ 1,000\) bond converted to 110 shares of common stock. (Record common stock entry in whole dollars. Round up.) June 1 Acquired equipment with a fair market value of \(\$ 90,000\) in exchange for 300 shares of preferred stock. \(\begin{array}{lrl}\text { Sept. } & 1 & \text { Acquired } 15,000 \text { shares of common stock for cash at } \$ 20 \text { per } \\ \text { Nov. } & 21 & \text { Issued } 5,000 \text { shares of common stock at } \$ 22 \text { cash per share. }\end{array}\) Dec. 28 Sold 1,000 treasury shares at \(\$ 23\) per share. 31 Closed net income of \(\$ 145,000\), to the Retained Earnings account. Required a. Set up T-accounts for the stockholders' equity accounts as of the beginning of the year and enter the January 1 balances. b. Prepare journal entries for the given transactions and post them to the T-accounts (set up any additional T-accounts needed). Do not prepare the journal entry for the Dec. 31 transaction, but post the appropriate amount to the Retained Earnings T-account. Determine the ending balances for the stockholders' equity accounts.

Treasury Stock Pomona Corporation issued 60,000 shares of \(\$ 3\) par value common stock at \(\$ 21\) per share and 9,000 shares of \(\$ 30\) par value, ten percent preferred stock at \(\$ 85\) per share. Later, the company purchased 2,000 shares of its own common stock at \(\$ 23\) per share. a. Prepare the journal entries to record the share issuances and the purchase of the common shares. b. Assume that Pomona sold 1,500 shares of the treasury stock at \(\$ 30\) per share. Prepare the general journal entry to record the sale of this treasury stock. c. Assume that Pomona sold the remaining 500 shares of treasury stock at \(\$ 20\) per share. Prepare the journal entry to record the sale of this treasury stock.

Dividend Distribution Bowen Corporation has the following shares outstanding: 15,000 shares of \(\$ 50\) par value, six percent preferred stock and 50,000 shares of \(\$ 5\) par value common stock. During its first three years in business, the firm declared no dividends in the first year, \(\$ 140,000\) of dividends in the second year, and \(\$ 60,000\) of dividends in the third year. a. If the preferred stock is cumulative, determine the total amount of dividends paid to each class of stock in each of the three years. b. If the preferred stock is noncumulative, determine the total amount of dividends paid to each class of stock in each of the three years.

Conversion of Preferred Stock into Common Stock Givens \& Sons, Inc., has 20,000 shares of \(\$ 50\) par value, nine percent preferred stock and 100,000 shares of \(\$ 0.50\) par value common stock outstanding. The preferred stock is convertible into the company's common stock at a conversion rate of \(1-\) to- 40 ; that is, each share of preferred stock is convertible into 40 shares of common stock. The preferred stock had been sold for its par value when issued. Prepare the journal entry to record the conversion of all of the company's preferred stock into common stock.
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