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Chapter 11: Problem 3

Forward Stock Split On September 1, Cambridge Company has 500,000 shares of \(\$ 15\) par value common stock that are issued and outstanding. The general ledger shows the following account balances relating to the common stock: On September 2, Cambridge splits its stock 3-for-2 and reduces the par value to \(\$ 10\) per share. a. How many shares of common stock are issued and outstanding immediately following the stock split? b. What is the balance in the Common Stock account immediately following the stock split? c. What is the likely reason that Cambridge Company split its stock?

Short Answer

Expert verified
a. 750,000 shares. b. $7,500,000. c. To increase affordability and liquidity of shares.

Step by step solution

01

Calculate New Shares After Split

The exercise describes a 3-for-2 stock split, meaning for every 2 shares held, each shareholder now has 3 shares. The company initially had 500,000 shares outstanding. To find the new number of shares, calculate: \[ \text{New Shares} = \text{Old Shares} \times \frac{3}{2} = 500,000 \times \frac{3}{2} = 750,000 \] So, the new number of issued and outstanding shares is 750,000.
02

Determine the New Par Value

In a stock split, the par value of each share is typically adjusted to reflect the increased number of shares. Initially, the par value was \( \\(15 \) per share. Post-split, it changes to \( \\)10 \) per share as stated in the problem description.
03

Calculate New Common Stock Account Balance

The Common Stock account balance is determined by multiplying the number of shares by the par value. After the split:\[ \text{Common Stock Balance} = \text{New Shares} \times \text{New Par Value} = 750,000 \times 10 = \\(7,500,000 \] Thus, the Common Stock account balance is \( \\)7,500,000 \) immediately after the stock split.
04

Reason for the Stock Split

Companies may split their stock to make shares more affordable to investors, increase liquidity, and broaden shareholder base. A lower share price generally increases accessibility and trading volume.

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Key Concepts

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

Common Stock
Common stock represents partial ownership in a company, meaning that shareholders can claim a portion of the profit. When a company issues common stock, it is essentially selling small bits of ownership to investors. These shares are traded on the stock market, allowing investors to buy and sell ownership stakes in the company.

Common stockholders usually have voting rights in corporate decisions, typically on a one-share-one-vote basis. They might also receive dividends, which are portions of the company's earnings distributed to shareholders. However, dividends are not guaranteed, as companies may choose to reinvest profits back into the business.
  • Represents ownership in a company.
  • Includes voting rights and potential dividends.
  • Can appreciate or depreciate in value based on market conditions.
Par Value
Par value is a nominal or face value assigned to a share of stock. It is an arbitrary value and does not necessarily reflect the stock's market price. Some companies set a par value to fulfill legal obligations, and others use it as an accounting measure.

For common stocks, the par value might be quite low, or even just symbolic. A stock split usually involves adjusting the par value. For example, if shares were split and the par value decreased, as seen in a 3-for-2 stock split, this adjustment reflects the increased number of shares issued. Such changes ensure that the total par value remains proportional to the equity distribution.
  • Arbitrary value for shares, often very low or symbolic.
  • Adjusted during stock splits to reflect new share quantities.
  • Used for legal or accounting purposes.
Shareholder Equity
Shareholder equity represents the net assets of a company and can be seen as the net worth of a corporation. It is calculated by subtracting total liabilities from total assets. These funds belong to the company's shareholders, as residual interest after all debts have been paid.

In the context of stock splits, shareholder equity remains unchanged. Though more shares are issued, the total value of all shares combined doesn't change鈥攐nly their distribution among individual shares does. Thus, each share's par value or price might decrease, but the overall equity remains the same.
  • Calculated as total assets minus total liabilities.
  • Represents the net worth and ownership of the company.
  • Remains unchanged during a stock split.
Liquidity
Liquidity refers to how easily assets, like stocks, can be converted into cash without affecting the asset's price. In the stock market, liquidity means how easily shares can be bought or sold at stable prices. High-liquidity stocks allow for transactions with minimal price changes.

One reason a company like Cambridge might split its stock is to increase liquidity. A lower share price typically makes stocks more accessible to a broader range of investors, thereby increasing trading volume. More active trading often leads to better liquidity, as there are more buyers and sellers in the market.
  • How easily assets can be converted to cash.
  • Higher liquidity means stable prices during trading.
  • Stock splits can increase market liquidity by reducing share prices.

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Most popular questions from this chapter

Change in Stockholders' Equity Nikron Corporation issued 20,000 shares of \(\$ 0.50\) par value common stock during the year for \(\$ 20\) each. Nikron also repurchased treasury stock for \(\$ 15,000\). Net income for the year was \(\$ 140,000\). The company also paid cash dividends of \(\$ 25,000\). What was the total change in Nikron's stockholders' equity for the year?

Share Issuances for Cash Chase, Inc., issued 10,000 shares of \(\$ 20\) par value preferred stock at \(\$ 50\) per share and 8,000 shares of no-par value common stock at \(\$ 20\) per share. The common stock has no stated value. All issuances were for cash. a. Prepare the journal entries to record the share issuances. b. Prepare the journal entry for the issuance of the common stock assuming that it had a stated value of \(\$ 10\) per share. c. Prepare the journal entry for the issuance of the common stock assuming that it had a par value of \(\$ 2\) per share.

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?

What features make preferred stock similar to debt? What features make it similar to common stock?

Characteristics of a Corporation Label each of the following characteristics of a corporation as either an (A) advantage or a (D) disadvantage: a. Organizational costs b. Continuity of existence c. Capital raising capability d. Separate legal entity
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