Monday, 9 July 2012

Stock Dividend Vs Stock Split (Critical Review)


By Jackie, Researcher
Topic: Education
Area of discussion: Finance
Chapter: Dividend policy
Subchapter: Alternatives to cash dividends – Stock dividend & Stock split

The objectives of this research are to find out what are the major differences and similarities between stock dividend and stock split, what are the effects on financial statements when a company issues a stock dividend or a stock split, how to enter those transaction into the appropriate accounts and the required adjustment that ought to be made to the financial statements. By the way, this topic is very popular as questions are often set out from this chapter in finance examination. Therefore, it is good to actually understand and gain some knowledge about the basic concept of stock dividend and stock split although we might not be playing shares in real-life.

Introduction
In term of definition, stock dividend (also known as ‘scrip dividend’) is a dividend payment made in the form of additional shares, rather than a cash payout. Ideally, company may decide to distribute stock to shareholders instead of cash dividend if the company’s cash availability is in unfavourable condition. These distributions are generally acknowledged in the form of fractions paid per existing share. An example would be a company issuing a 5% stock dividend for each single share held. On the other hand, stock split (also known as ‘scrip issue’, ’bonus issue’ and ‘free issue’) is a corporate action in which a company existing shares are divided into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because no real value has been added as a result of the split.

Let’s take a look at this example: 

Question taken from IICS past year examination, also special thanks to Mr.Lim for his kind teachings. 

Solution for (i):

When 10% stock is declared, then the number of shares outstanding will also be increased by 10%, that is from 10,000 shares to 10,000(1.1)=11,000 shares.

This indirectly indicates that the new share issued is equal to 1,000 shares.

The overall effects on the owner’s equity accounts are:

Common stock (£1 par value) will increase by £1,000 (£1 par value per share x 1,000 newly issued shares due to 10% stock dividend).

Capital surplus (also known as ‘share premium’) will be also increase by £24,000. Please note that share premium is equal to market price minus the par value. Thus, share premium per share is £25 per share - £1 per share = £24 per share. After that, this share premium per share needs to be multiplied by 1,000 shares in order to get £24,000 which is the total share premium due to 10% stock dividend.

Retained earnings will be decreased by £25,000. This is derived from the market price which is £25 per share, then multiply with 1,000 shares in order to get £25,000.


Alteration in owner's equity accounts after 10 percent stock dividend is declared


Solution for (ii):

(This is actually more or less, quite similar with question (i))

When 25% stock is declared, then the number of shares outstanding will also be increased by 25%, that is from 10,000 shares to 10,000(1.25)=12,500 shares.

This indirectly indicates that the new share issued is equal to 2,500 shares.

The overall effects on the owner’s equity accounts are:

Common stock (£1 par value) will increase by £2,500 (£1 par value per share x 2,500 newly issued shares due to 25% stock dividends).

Capital surplus (also known as ‘share premium’) will be also increase by £60,000. Please note that share premium is equal to market price minus the par value. Thus, share premium per share is £25 per share - £1 per share = £24 per share. After that, this share premium per share needs to be multiplied by 2,500 shares in order to get £60,000 which is the total share premium due to 25% stock dividend.

Retained earnings will be decreased by £62,500. This is derived from the market price which is £25 per share, and then multiplies with 2,500 shares in order to get £62,500.


Alteration in owner's equity accounts after 25 percent stock dividend is declared


Solution for (iii):

In this case, ‘three-for-one stock split’ means each existing share is divided into three. Therefore, the shares outstanding after the stock split will be 30,000 shares (10,000 shares x 3). When this happen the par value per share will also divided by the split ratio of three, i.e. £1 ÷ 3 = £0.3333 per share. Hence, these are the only effects of the split.

Please note that the equity accounts are unchanged except that the par value of the stock is changed by the ratio of new shares to old shares.


Alteration in owner's equity accounts after a 'three-for-one stock split' is declared


Solution for (iv):

For this question, it is a bit special because it is deal with ‘reverse stock split’, a condition where the shares are combined instead of splitting according to its ratio. For ‘one-to-five reverse stock split’, it simply means that for every five existing shares, they are combined into one share. Thus, 10,000 existing shares will become 2,000 shares after the reverse stock split (10,000 shares ÷ 5). The par value will change to £5 per share (£1 x 5).


Alteration in owner's equity accounts after a 'one-for-five reverse stock split' is declared



Extra sharing:
Additional question and answer of which I took from my college past year question, it is solely focus on essay part (the differences). Thus, very theoretical and need deep analytical skills.

This Q&A explains the differences between stock dividend and stock split, their effects on equity accounts
 and their respective accounting treatment with examples to aid explanation.


Additional readings, related links and references:

Part 5: Stock Splits and Stock Dividends

Chapter 14: Stock Splits and Stock Dividends

Stock Dividends and How They Are Different From Stock Splits

Chapter 18: Shareholders’ Equity (Stock Dividends and Splits)

The Effect Of Stock Splits & Stock Dividends On The Market Share Price

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