Question

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

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

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.

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.

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.