Stock split is the issuance of additional shares by a company to its shareholders without receiving any related contribution from them. Such an issue increases the number of shares issued and outstanding without increasing the total balance of common stock and market capitalization of the company. The effect of stock split is to split the par value and market price per share. In fact, the sole purpose of the stock split is to reduce the market price per share so as to make it more attractive for investors.
Stock splits are designed by companies in regard to their intended effect on the market price. If a company wants to reduce its market price to half it will issue 2-for-1 stock split which means the company shall issue addition 1 share per 1 share currently issued and outstanding thereby doubling the total number of shares. There might be a 3-for-2 stock split, for example, which means that 3 shares are to be issued for each 2 shares of currently issues shares.
Stock split has no effect on balance of any equity account. It just increases the number of shares and reduces par value.
Z Ltd. has 2 million of $10 par value common stock issued and outstanding which is currently trading at $300 per share. The management believes that the share price is too high and it intends to reduce it to its 1/3.
The company would need to issue a 3-for-1 stock split which means that for each of currently issued common shares the company shall issue 3 shares. It will increase the total number of shares issued and outstanding to 6 million (2 million × 3) resulting in a par value of $3.33 ($10 ÷ 3) and a market price of $100 ($300 ÷ 33).
It will not affect balance in any of the accounts.
Written by Obaidullah Jan, ACA, CFA and last modified on